Flexible biofuel mandates – a tool for reducing agricultural price spikes?

This question is investigated by Defra economists in a recent report.

The EU Renewable Energy Directive’s target for 10 per cent renewable energy in transport by 2020 has seen a lot of criticism given the overwhelming reliance on conventional biofuels produced from food and feed crops and their alleged mal-performance on environmental and social criteria. On the social dimension, biofuels are blamed for contributing to food price increases and the recent agricultural crop price spikes. To what extent this can be expected to be the case up to 2020 is the subject of analysis of a recent IEEP report.

Most of the analysis of the 2007-08 price spikes concluded that biofuels were one among several factors, but not the overwhelming driver of price spikes. Furthermore, economic models do not agree on the price effects of biofuel use in 2020, with likely impacts ranging from small to significant: IEEP’s report found that the most significant price increases are projected for oilseeds and vegetable oils (with increases in world prices in 2020 of between 8 to 20 and 5 to 36 per cent, respectively). Wheat prices are projected to increase by between 1 and 13 per cent and the majority of studies project increases of cereal / maize prices of up to 8 per cent and of sugar prices of up to 2 per cent. Nevertheless, the discussion on biofuels’ role in agricultural price increases is likely to soar again in coming months in the light of the currently observed price increases for corn, soy and also wheat in response to the severe drought in the US and subsequent cuts in projected harvests.

While the immediate cause of the recent price spikes are clearly weather related and hence on the supply side, they take place in the presence of US biofuel mandates and roughly one third of US corn output going into ethanol production. The policy context is topical too with the European Commission having to report on social impacts of EU biofuel use including impacts on food availability and affordability by the end of this year.

Defra economists have proposed flexible biofuel mandates as a way forward in this discussion. ‘Flexibility’ is understood as (temporarily) reducing or abandoning altogether biofuel mandates when agricultural price increases pass a certain threshold (not further defined). So, instead of rigidly mandating a certain usage of biofuel use year on year, the volumes could decrease in times of price spikes so that more crops would be available for food and feed use. In that way, the proportion of crops that would in ‘normal’ years go into biofuel production would be transformed into a reserve stock, or ‘virtual grain stock’ as the authors call it, potentially reducing price spikes. Their economic modelling shows that abolishing EU blending requirements in the presence of price spikes (triggered in the model by a reduction of EU wheat or coarse grain harvested area by 25 per cent) could reduce a coarse grain price spike by up to 15 per cent and a wheat price spike by between 10 and 35 per cent. Cutting in half the US biofuel mandate would even reduce a coarse grain spike by around 40 per cent.

As the report rightly states, it is crucial what decision rule is in place that will trigger flexible mandates and what flexibility entails in practice. A proposal in that direction has been made by Bruce Babcock, who suggests a ‘banking’ and borrowing’ system in the US by which in years of above average harvests and above target biofuel production, this ‘overshooting’ could balance below-target biofuel production in years of poor harvests.

These are intelligent ideas which seem well worth progressing. Food price increases hit the poorest in society so measures to reduce this effect are worth following up. However so too are more fundamental ways of avoiding the food price and negative environmental effects of biofuels. One is to accelerate the development of advanced biofuels which can utilise cellulosic, non-food, raw materials. Another is to impose stricter rules on indirect land use change (ILUC) to ensure that this from of renewable energy really does reduce overall greenhouse gas emissions.

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25 Jul 2012