This will be the last post of this blog. Most of its concepts have already been expressed in previous posts, but I want that if someone by chance stumbles upon this blog, the first thing they see is the most important message I want to convey in it.
I started this blog in Oct 2007 with an analysis of the international monetary system, concluding that the US current account would eventually be balanced by a drop in US imports out of either a US recession or a plunge in the dollar's value, depending on the Fed's monetary policy, and that in my view the first path would be the best. By now it is clear that they are headed down the second (with a twist as explained in the last two paragraphs).
Then in Nov 2007 I analyzed the prospects for the oil market in 2008, concluding that, save for a significant US-led OECD recession, the oil price would be significantly higher by the end of 2008. Even though oil (actually total liquids) production has risen more than I expected back then, by now it is clear which way the oil price is heading and how fast.
Then in Dec 2007 I commented on the huge extent to which current economic thinking (not only of theorists, but of people like Bernanke who make decisions which significantly affect the course of events) was disconnected from physical reality. Specifically on the economists' failure to perceive that now it is the physical limits to growth which are becoming the main constraint to economic output, and that in this new scenario it is most unwise to keep stimulating demand. By now it is clear that the disconnect is still as complete as it ever was.
Finally in Jan 2008 I commented on the threat that biofuels posed to world food production: as biofuels are a direct replacement for petroleum products, their prices are directly proportional to those of the petroleum products replaced, plus or less differential taxes/subsidies. Therefore, a higher crude oil price increases the profitability of biofuel production while at the same time decreasing the profitability of food production. As a result, arbitraging based on profits per acre/hectare drives the allocation of agricultural production out of food and into biofuels. As more agricultural production is diverted into biofuels, biofuel production increases and fuel prices consequently tend to stabilize, while food production decreases and food prices consequently rise, until the profitability of food production becomes once again competitive with that of biofuel production and a new equilibrium state is reached where no further diversion occurs. But the key point is that the food production level at this new equilibrium state is LOWER than that at the original state.
As anyone aware of Hubbert's Peak understands, in the absence of a worldwide voluntary reduction of crude oil demand in line with the future peaking and subsequent decline of crude oil production, the prospects for the oil price are of a relentless rise. That, through the profit-based arbitraging mechanism described above, will drive the world into successive new equilibrium states with higher biofuel production and lower food production. Obviously the process will eventually stop before 100% of the food gets turned into fuel. But along the way a large number of poor people wanting to eat will have been outbid by the rich and middle class wanting to fill their tanks.
On the demand side, it is clear that the current path is the exact opposite of what would be required to prevent a relentless rise of the oil price, as the populations of giant emerging economies, particularly China and India, increasingly adopt the oil consumption patterns of the citizens of OECD nations. For which they obviously cannot be reproached: how could Americans ask the Chinese to keep riding bikes as they keep driving their SUVs? That generalized desire to adopt or keep the happy motoring way of life, together with the determination shown by OECD Central Bankers to avoid or minimize a recession (China will probably not have a recession regardless of what happens in the US), just guarantee the outcome that is clearly seen by now: oil demand will not abate and oil prices will keep their march up, dragging food prices along with them.
In this context, any government-induced price distortion (through differential taxes/subsidies) that increases the profitability of biofuel production over that of food production directly amounts to hastening the appearance and aggravating the degree of the coming food crunch. And here is where the issue in the first post (Oct 2007) comes into play: turning an ever greater share of US corn to ethanol (and then soybeans to biodiesel) will cause in a few years the halving of US agricultural exports in volume and their doubling in dollars (i.e. quadrupling agricultural prices). That will substantially reduce the US current account deficit and give the US a significant strategic advantage.
The US has certainly the right to follow that path. But they also have the duty to tell the world openly that they will do it. Like: "Along the coming years and decades our food exports will become progressively lower in volume, and the same will probably happen to total world food production. It is conceivable that they could be half their current volume in 10 years. People, and particularly poor people, should have it in mind when making procreation decisions."
Showing posts with label biofuels. Show all posts
Showing posts with label biofuels. Show all posts
2008-03-14
2008-01-14
On the Global Risks 2008 Report for Davos
The approach taken by the Global Risks 2008 Report for the Davos World Economic Forum is a cause for both hope and concern. On the one hand, it is auspicious to see that it includes the world's two most critical and urgent issues, food and energy security, among the four main global risks. But on the other hand the Report fails to assign those issues their real degree of severity, and perhaps more importantly, it does not seem to understand the real dynamics driving them.
To start with, the Report assertion that, of the four issues, "systemic financial risk is the most immediate and, from the point of view of economic cost, the most severe", either has to be construed as revealing a serious lack of understanding of the immediacy and severity of the problems affecting the food supply, or else must be qualified as outrageous. Because the consequences of a systemic financial crisis, however severe, cannot be compared to the starvation of millions.
Notably, the Report states clearly - and correctly - that the growing use of food crops for biofuel production is a key driver of the increasing risk to food security. But although it initially states that "the consequences, particularly for the most vulnerable communities, may be harsh", it ends the treatment of the subject stating that "the consequences of all these trends for perpetuating the escalation of food prices are difficult to predict." Actually, the consequences are not so difficult to predict if the analysis is ultimately focused on food production levels rather than prices, because global food production is a direct determinant of the population level that can be sustained. I.e., if food production drops because of increased biofuel production, it will have as a direct consequence that fewer people will be able to obtain adequate nutrition. And to evaluate the potential share of global food production that could eventually be diverted to biofuels, and the timing for that, it is essential to correctly understand the dynamics driving the diversion process.
Quite simply, the main driver of the growth in biofuel production is the rise in the crude oil price. As biofuels are a direct replacement for petroleum products, their prices are directly proportional to those of the petroleum products replaced, plus or less differential taxes/subsidies. Therefore, a higher crude oil price increases the profitability of biofuel production while at the same time decreasing the profitability of food production. As a result, arbitraging based on profits per acre starts driving the allocation of agricultural production (and in turn of land) out of food and into biofuels. As more agricultural production (and land) is diverted into biofuels, biofuel production will increase and fuel prices will consequently tend to stabilize, while food production will decrease and food prices will consequently rise, until the profitability of food production becomes once again competitive with that of biofuel production and a new equilibrium state is reached where no further diversion occurs. But it is crucial to note that the food production level at this new equilibrium state is LOWER than that at the original state. (Notably, the Report does mention that "others believe that markets will gradually readjust to shortages as higher prices make it profitable again to grow crops for food". But it fails to mention that the new equilibrium state occurs at a lower food production level.)
Not only is the above dynamics entirely logical, it is also supported by facts as shown in the recently published study "Fermenting the Food Supply - Modelling Biofuel Production as an Infectious Growth on Food Production" by Stuart Staniford, PhD, available at http://www.theoildrum.com/node/2431.
Once understood that it is the rise in the crude oil price what drives the biofuel boom through a simple profit-based arbitraging mechanism, the next step in order to assess the potential share of global food production that could eventually be diverted to biofuels is to evaluate the prospects for the oil price. Which must be done on both a short- and long-term basis.
For the short term, the current data and projections from both the US Energy Information Administration (EIA) as of Jan. 08, 2008 at http://www.eia.doe.gov/emeu/steo/pub/contents.html (table 3a) and the OECD International Energy Agency (IEA) as of Dec. 14, 2007 at http://omrpublic.iea.org/currentissues/full.pdf speak quite loudly:
World oil production
year 2005 2006 2007 2008
EIA 84.6 84.6 84.8 87.6 (wishful thinking?)
IEA 84.6 85.4 85.5
World oil consumption
year 2005 2006 2007 2008
EIA 83.7 84.8 85.9 87.5
IEA 83.9 84.7 85.7 87.8
Given the trend in global oil production for 2005-2007, and the fact that both the EIA and the IEA currently project 2008 global demand being respectively 2.7 Mbpd and 2.3 Mpbd higher than 2007 global supply, it is painfully clear that either global oil production breaks decisively from its recent performance and surges in 2008 - which looks improbable at best - or global oil demand will be brought down to convergence with supply, in turn either by a significant recession in the OECD or by an oil price that will surge deep into the triple digits in 2008, in euros as well as in dollars. The last possibility will have a significant short-term impact in global biofuel (and food) production, since, as shown by the cited study, "when oil prices spike up, a year or so later we have a new burst of ethanol capacity under construction (which then comes on stream 1-2 years after that)." And this impact will take place against the background of an already dire situation, as described by the Dec 17, 2007 FAO communique "FAO calls for urgent steps to protect the poor from soaring food prices" at http://www.fao.org/newsroom/en/news/2007/1000733/index.html.
For the long term, the determinant factor is a constraint from physical reality: the fact that global oil reserves are finite, and that as a result global oil production will eventually reach a peak and then commence a relentless decline. The peaking event is termed "Hubbert's Peak" after the late Shell geologist M. King Hubbert, PhD, who in 1956 predicted that US oil production would peak in 1970 as it effectively did. Today, most analysts without vested interests are predicting global Hubbert's Peak to take place in the 2010-2012 timeframe. Therefore, in the absence of a worldwide voluntary reduction of crude oil demand in line with the future peaking and subsequent decline of crude oil production, the long term prospects for the oil price are of a relentless rise. Which through the profit-based arbitraging mechanism described above will drive the world into successive new equilibrium states with higher biofuel production and lower food production. Obviously the process will eventually stop before 100% of the food gets turned into fuel. The question is, at what point? When we have a bidding war between the gas tanks of the global middle and wealthy classes and the dinner tables of the poor, where does that reach equilibrium?
Regarding global crude oil demand, the current path is the exact opposite of what would be required to prevent a relentless rise of the oil price, as the populations of giant emerging economies, particularly China and India, increasingly adopt the oil consumption patterns of the citizens of OECD nations. For which they obviously cannot be reproached: how could Americans ask the Chinese to keep riding bikes as they drive their SUVs?
To sum up, the prospects for global crude oil production - based on geological constraints -, plus the prospects for crude oil demand - based on human nature-, plus the profit-based arbitraging mechanism for diverting agricultural production into biofuels, all make for a very bleak picture for the global food supply. Indeed, as shown in the cited study, global biofuel production could be consuming half the global food supply within about six or seven years.
Of the three factors powering the process, increasing global crude oil production in the long term is physically beyond the reach of policy-makers (and while it could be increased in the short term, given the finiteness of reserves that would imply a steeper decline later). But acting in a concerted and collaborative way to stop and reverse growth in global oil demand is not. And while the bulk of this growth comes from emerging economies, it is not conceivable to expect it to stop without the developed economies setting the example by drastically reducing their own consumption. As for the food/biofuel arbitraging mechanism, any government-induced price distortion that increases the profitability of biofuel production over that of food production through differential taxes/subsidies directly amounts to hastening the appearance and aggravating the degree of the coming food crunch.
Again, this is not an issue which the world can take years to study: it is already hurting, as per the FAO communique, and the factor that drives it - rising crude oil prices - is poised to surpass its 2007 strong performance in 2008 if a significant OECD recession does not materialize promptly.
And if world leaders decide that - while physically feasible - it is politically impossible to act in a concerted and collaborative way to stop and reverse global oil demand growth, whereby the prospects for world food production will be to decline to a level substantially lower than today's, they must at the very least make those prospects openly and plainly known to everyone. For even if it could be argued that it is politically impossible to prevent the third horseman from coming back - this time driving a biofuel-powered SUV -, there can be no excuse for keeping people ignorant of the fact that he is coming for dinner. For their dinner.
To start with, the Report assertion that, of the four issues, "systemic financial risk is the most immediate and, from the point of view of economic cost, the most severe", either has to be construed as revealing a serious lack of understanding of the immediacy and severity of the problems affecting the food supply, or else must be qualified as outrageous. Because the consequences of a systemic financial crisis, however severe, cannot be compared to the starvation of millions.
Notably, the Report states clearly - and correctly - that the growing use of food crops for biofuel production is a key driver of the increasing risk to food security. But although it initially states that "the consequences, particularly for the most vulnerable communities, may be harsh", it ends the treatment of the subject stating that "the consequences of all these trends for perpetuating the escalation of food prices are difficult to predict." Actually, the consequences are not so difficult to predict if the analysis is ultimately focused on food production levels rather than prices, because global food production is a direct determinant of the population level that can be sustained. I.e., if food production drops because of increased biofuel production, it will have as a direct consequence that fewer people will be able to obtain adequate nutrition. And to evaluate the potential share of global food production that could eventually be diverted to biofuels, and the timing for that, it is essential to correctly understand the dynamics driving the diversion process.
Quite simply, the main driver of the growth in biofuel production is the rise in the crude oil price. As biofuels are a direct replacement for petroleum products, their prices are directly proportional to those of the petroleum products replaced, plus or less differential taxes/subsidies. Therefore, a higher crude oil price increases the profitability of biofuel production while at the same time decreasing the profitability of food production. As a result, arbitraging based on profits per acre starts driving the allocation of agricultural production (and in turn of land) out of food and into biofuels. As more agricultural production (and land) is diverted into biofuels, biofuel production will increase and fuel prices will consequently tend to stabilize, while food production will decrease and food prices will consequently rise, until the profitability of food production becomes once again competitive with that of biofuel production and a new equilibrium state is reached where no further diversion occurs. But it is crucial to note that the food production level at this new equilibrium state is LOWER than that at the original state. (Notably, the Report does mention that "others believe that markets will gradually readjust to shortages as higher prices make it profitable again to grow crops for food". But it fails to mention that the new equilibrium state occurs at a lower food production level.)
Not only is the above dynamics entirely logical, it is also supported by facts as shown in the recently published study "Fermenting the Food Supply - Modelling Biofuel Production as an Infectious Growth on Food Production" by Stuart Staniford, PhD, available at http://www.theoildrum.com/node/2431.
Once understood that it is the rise in the crude oil price what drives the biofuel boom through a simple profit-based arbitraging mechanism, the next step in order to assess the potential share of global food production that could eventually be diverted to biofuels is to evaluate the prospects for the oil price. Which must be done on both a short- and long-term basis.
For the short term, the current data and projections from both the US Energy Information Administration (EIA) as of Jan. 08, 2008 at http://www.eia.doe.gov/emeu/steo/pub/contents.html (table 3a) and the OECD International Energy Agency (IEA) as of Dec. 14, 2007 at http://omrpublic.iea.org/currentissues/full.pdf speak quite loudly:
World oil production
year 2005 2006 2007 2008
EIA 84.6 84.6 84.8 87.6 (wishful thinking?)
IEA 84.6 85.4 85.5
World oil consumption
year 2005 2006 2007 2008
EIA 83.7 84.8 85.9 87.5
IEA 83.9 84.7 85.7 87.8
Given the trend in global oil production for 2005-2007, and the fact that both the EIA and the IEA currently project 2008 global demand being respectively 2.7 Mbpd and 2.3 Mpbd higher than 2007 global supply, it is painfully clear that either global oil production breaks decisively from its recent performance and surges in 2008 - which looks improbable at best - or global oil demand will be brought down to convergence with supply, in turn either by a significant recession in the OECD or by an oil price that will surge deep into the triple digits in 2008, in euros as well as in dollars. The last possibility will have a significant short-term impact in global biofuel (and food) production, since, as shown by the cited study, "when oil prices spike up, a year or so later we have a new burst of ethanol capacity under construction (which then comes on stream 1-2 years after that)." And this impact will take place against the background of an already dire situation, as described by the Dec 17, 2007 FAO communique "FAO calls for urgent steps to protect the poor from soaring food prices" at http://www.fao.org/newsroom/en/news/2007/1000733/index.html.
For the long term, the determinant factor is a constraint from physical reality: the fact that global oil reserves are finite, and that as a result global oil production will eventually reach a peak and then commence a relentless decline. The peaking event is termed "Hubbert's Peak" after the late Shell geologist M. King Hubbert, PhD, who in 1956 predicted that US oil production would peak in 1970 as it effectively did. Today, most analysts without vested interests are predicting global Hubbert's Peak to take place in the 2010-2012 timeframe. Therefore, in the absence of a worldwide voluntary reduction of crude oil demand in line with the future peaking and subsequent decline of crude oil production, the long term prospects for the oil price are of a relentless rise. Which through the profit-based arbitraging mechanism described above will drive the world into successive new equilibrium states with higher biofuel production and lower food production. Obviously the process will eventually stop before 100% of the food gets turned into fuel. The question is, at what point? When we have a bidding war between the gas tanks of the global middle and wealthy classes and the dinner tables of the poor, where does that reach equilibrium?
Regarding global crude oil demand, the current path is the exact opposite of what would be required to prevent a relentless rise of the oil price, as the populations of giant emerging economies, particularly China and India, increasingly adopt the oil consumption patterns of the citizens of OECD nations. For which they obviously cannot be reproached: how could Americans ask the Chinese to keep riding bikes as they drive their SUVs?
To sum up, the prospects for global crude oil production - based on geological constraints -, plus the prospects for crude oil demand - based on human nature-, plus the profit-based arbitraging mechanism for diverting agricultural production into biofuels, all make for a very bleak picture for the global food supply. Indeed, as shown in the cited study, global biofuel production could be consuming half the global food supply within about six or seven years.
Of the three factors powering the process, increasing global crude oil production in the long term is physically beyond the reach of policy-makers (and while it could be increased in the short term, given the finiteness of reserves that would imply a steeper decline later). But acting in a concerted and collaborative way to stop and reverse growth in global oil demand is not. And while the bulk of this growth comes from emerging economies, it is not conceivable to expect it to stop without the developed economies setting the example by drastically reducing their own consumption. As for the food/biofuel arbitraging mechanism, any government-induced price distortion that increases the profitability of biofuel production over that of food production through differential taxes/subsidies directly amounts to hastening the appearance and aggravating the degree of the coming food crunch.
Again, this is not an issue which the world can take years to study: it is already hurting, as per the FAO communique, and the factor that drives it - rising crude oil prices - is poised to surpass its 2007 strong performance in 2008 if a significant OECD recession does not materialize promptly.
And if world leaders decide that - while physically feasible - it is politically impossible to act in a concerted and collaborative way to stop and reverse global oil demand growth, whereby the prospects for world food production will be to decline to a level substantially lower than today's, they must at the very least make those prospects openly and plainly known to everyone. For even if it could be argued that it is politically impossible to prevent the third horseman from coming back - this time driving a biofuel-powered SUV -, there can be no excuse for keeping people ignorant of the fact that he is coming for dinner. For their dinner.
2008-01-08
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:
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 http://www.biodiesel.com.ar/download/emerging_liquid_biofuel_markets.pdf
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).
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 http://www.biodiesel.com.ar/download/emerging_liquid_biofuel_markets.pdf
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).
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