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Global Impacts of the Mandate under a Carbon Ujjayant Chakravorty, Marie-Hélène Hubert

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Ujjayant Chakravorty, Marie-Hélène Hubert. Global Impacts of the Biofuel Mandate under a Carbon Tax. American Journal of Agricultural Economics, Oxford University Press (OUP), 2013, 95 (2), pp.282 - 288. ￿10.1093/ajae/aas038￿. ￿halshs-01892186￿

HAL Id: halshs-01892186 https://halshs.archives-ouvertes.fr/halshs-01892186 Submitted on 10 Oct 2018

HAL is a multi-disciplinary open access L’archive ouverte pluridisciplinaire HAL, est archive for the deposit and dissemination of sci- destinée au dépôt et à la diffusion de documents entific research documents, whether they are pub- scientifiques de niveau recherche, publiés ou non, lished or not. The documents may come from émanant des établissements d’enseignement et de teaching and research institutions in or recherche français ou étrangers, des laboratoires abroad, or from public or private research centers. publics ou privés. American Journal of Agricultural Economics Advance Access published June 8, 2012

GLOBAL IMPACTS OF THE BIOFUEL MANDATE UNDER A CARBON TAX

UJJAYANT CHAKRAVORTY AND MARIE-HÉLÈNE HUBERT

Many countries are actively promoting bio- mandates lead to an increase in indirect car- fuel mandates as a means of reducing carbon bon emissions (Searchinger et al. 2008; Chen, emissions and dependence on imported oil. In Huang and Khanna 2012). the , the Federal Renewable Fuel None of these papers examine the joint Standard (RFS) calls for the minimum use of 15 effects of the US and EU mandates and a billion gallons per year of corn by 2015. carbon tax on a global model. We focus on Beyond 2015, the mandate calls for a steady this issue using a partial equilibrium model of increase in the use of second generation biofu- the world food and fuel markets developed by els to a level of 21 billion gallons in 2022. The Chakravorty et al. (2012). This model is unique EU mandate requires the share of bio- because it traces the effects of biofuel policies fuels to rise from the current share of 4% to by allowing for the endogenous conversion of 10% in 2020. marginal lands to farming in order to produce An important goal of these energy man- food and fuel. It determines where the biofu- dates is to reduce GHG emissions. However, els and food should be produced and on what many studies suggest that biofuel policies do quality of land (low,medium or high). Two bio- not induce significant reductions in emissions. fuel policies are considered. First, we focus on Chen, Huang and Khanna (2012) develop a the US and EU mandates without any carbon model of the US food and fuel sectors and con- tax. In the second scenario, the two mandates clude that the impact of the mandate alone in are accompanied by a carbon tax. In the regu- reducing GHG emissions is small,but increases lated countries, the mandates reduce when the mandate is accompanied by a sub- consumption and GHG emissions by trigger- sidy for second generation biofuels or a carbon ing a switch towards biofuels. But it differs tax. Other studies find that the biofuel mandate from a instrument in that it lowers can cause an increase in direct GHG emissions the price of vehicle miles traveled (VMT) and (de Gorter and Just 2009). By lowering the leads to a rise in the consumption of blended price of the blending fuel, the mandate when fuels.When the mandates are imposed together combined with a results in an increase with a carbon tax, direct emissions are lower in in fuel consumption, which can raise GHG the regulated countries. emissions. Lasco and Khanna (2010) develop Biofuel use in the US does not change sig- a partial equilibrium model of the US fuel sec- nificantly with a carbon tax, when the mandate tor and show that a combined and is in place. Hence indirect emissions do not increases ethanol demand and domestic pro- change appreciably in other countries that pro- duction in the US. GHG emissions increase duce and export biofuels to the US. Under compared to the no-intervention case. How- both policies, there is a leakage effect on the ever, all studies agree on one point: biofuel rest of the world. However, what changes is gasoline consumption. When the mandate is combined with the tax instrument, gaso- line use is lower in the US, hence leakage is higher in the rest of the world. Direct car- Ujjayant Chakravorty ([email protected]) is Professor of Eco- nomics at Tufts University (and Fellow, TSE and CESifo); bon emissions in the aggregate, go up. Indi- Marie-Hélène Hubert ([email protected]) is rect carbon emissions also increase some when Assistant Professor of Economics,University of Rennes 1 (CREM). the mandate is combined with the tax. Since This article was presented in an invited paper session at the 2012 ASSA annual meeting in Chicago, IL. The articles in these sessions carbon emissions from biofuels are released are not subjected to the journal’s standard refereeing process. during their production, a carbon tax in the

Amer. J. Agr. Econ. 1–7; doi: 10.1093/ajae/aas038 © The Author (2012). Published by Oxford University Press on behalf of the Agricultural and Applied Economics Association. All rights reserved. For permissions, please e-mail: [email protected] 2 Amer. J. Agr. Econ. regulated countries improves the competitive- biofuels.1 Land may be expanded by convert- ness of imported biofuels. Acreage brought ing lands not yet cultivated, which may be of into cultivation increases causing a rise in class 1, 2 or 3, one being the highest quality. indirect carbon emissions. The initial stock of available land is given. At We next describe the model used. Impacts of each period, new land may be brought under biofuel policies on food and fuel markets and cultivation. The cost of land is endogenously on GHG emissions are described in section 3. determined by the shadow price of the land Finally, section 4 concludes. constraint in the model. The cost of convert- ing new land is assumed to be increasing and convex with respect to the acreage converted. We adopt the same functional form as in Gouel The model and Hertel (2006). Land is brought into culti- vation when the land rent exceeds the cost of The world economy is composed of five regions, conversion.2 described below. Each region supplies and Total area available is the sum of land cur- consumes two food commodities (cereals; and rently under farming and land under other meat/dairy) and fuel for transportation. Trans- uses, such as pasture and forests. The initial port fuel is domestically produced from a blend global endowment of agricultural land is 1.5 of gasoline and biofuels. Biofuels may be first billion hectares (FAOSTAT).About 1.6 billion or second generation biofuels. Gasoline is pro- hectares of additional land are available for duced from crude oil and its price depends on cropping possibly at a higher cost of produc- the world oil market. Biofuels and food com- tion (FAO 2008). Most fallow land is located modities are traded between regions. In each in South America and Africa. Land under region, available land may be allocated to food the Conservation Reserve Program (CRP) is or energy. assumed to be available for crop production The regions we consider are: High Income in the US. Food production is assumed to Countries (HICs), Medium (MICs) and Low exhibit constant returns to scale for each land Income Countries (LICs), classified by gross class. Hence, regional food supply is just yield national product per capita. The HICs are times the land area. Improvements in agri- then divided into three groups: US, EU and cultural productivity are allowed to vary by other HICs since our study focuses on US region and land category. Crops are trans- and EU mandatory blending policies. Fast- formed into cereals and meat/dairy at cost growing countries like , and (final goods). are included in the MICs whose average We consider a representative biofuel in each gross national product per capita was about region. In the US, 94% of biofuel production US$5,700 in 2007, the benchmark year for the comes from corn ethanol, while 76% of EU model. Finally, the LICs are mainly nations production is biodiesel from rapeseed (EIA from Africa with average gross national prod- 2011). In the MICs, 94% of biofuels are pro- uct per capita of about $1,060 in 2007. duced from sugar cane. In the Other HICs and Demands for the two food products, cere- LICs, biofuel production is marginal. Second als and meat/dairy, and transport fuel, are generation biofuel technologies are assumed modeled using a Cobb-Douglas function. They to be available only in the US and EU. Cellu- are exogenously driven by population and losic ethanol in the US and Biomass-to-Liquid per capita income. We distinguish between diesel (BTL) in the EU have been identified meat/dairy and cereals to account for the as among the most competitive second gen- change in dietary habits. Meat/dairy products eration biofuels. Even if they are less land include all types of meat and dairy such as consuming, their production cost is higher than milk and butter. Cereals include all grains, that of first generation biofuels. Table 1 reports starch crops, sugar, sweeteners and oil crops. energy yields and production costs for first and The demand for fuel is in Vehicles Miles Trav- second generation biofuels. First generation eled (VMT). Since land quality varies by geographical 1 Crops are then transformed into cereals or meat/dairy prod- region, we disaggregate land into three classes. ucts. Of course, land could also be left fallow. Each land class (or land quality) is based on 2 We assume that emissions from land conversion and benefits their and soil characteristics (Eswaran, from biofuel production are instantaneous,meaning that there is no time lag between planting and harvesting.This may be a reasonable Beinroth and Reich 2003) and may be allocated approximation since crops like corn and sugarcane grow within a either to crops or to first or second generation year or less. Chakravorty and Hubert Global Impacts of the Biofuel Mandate under a Carbon Tax 3

Table 1. Characteristics of First and Second place.6 Finally, a $1.01/gallon subsidy is pro- Generation Biofuels by Region vided for second generation biofuels. However, the bigger push has come from renewable fuel First-generation Second-generation biofuels biofuels standard (RFS) mandates which were initially set at 7.5 billion gallons of biofuel by 2012, gal/ha US$/gal gal/ha US$/gal reaching 36 billion gallons in 2022. Ethanol use US 800 1.01 1,800 1.75 is expected to increase at least until 2015, while EU 400 0.55 2,000 2.25 the bulk of future growth in biofuel supplies is MICs 1,700 0.57 NA NA likely to come from second-generation biofu- els (). The Notes: NA implies that the technology is not yet available. Source: Biofuel also employs a mix of policies to encourage yields (FAO 2008; IEA 2009) production costs (FAO 2008; Eisentraut 2010; IEA 2009). biofuel use (Kojima, Mitchell, and Ward 2007). EU states have tax credits on biodiesel rang- yields differ by land quality. However, yields ing from 41-81 cents.We include an average tax of second generation biofuels are assumed to credit of 60 cents for the EU as a whole. In addi- be uniform across land classes since second tion,there is a 6.5% ad valorem tariff on biofuel gen crops are less demanding in terms of land imports. According to the EU 2009 Directive quality (van den Wall Bake et al. 2009). the biofuel share in transportation fuel is slated The oil market is modeled independently. to increase from current levels of 4% to 10% The initial stock of oil (including unconven- by 2020 (European Commission 2009). EU tional oils) available for transportation equals mandates have no minimum requirement on 154 billion gallons (World Energy Council second generation biofuels. 2010).3 To take into account the heterogene- Data on carbon footprints are taken from ity of oil reserves, extraction costs depend on Chakravorty et al. (2012). The model also cap- the cumulative quantity of oil used (Nordhaus tures indirect carbon emissions. We assume and Boyer 2000). Oil is then transformed into that respectively, 300 and 500 tons of CO2 gasoline or diesel.4 We model the production are released per hectare from land classes of energy using a CES specification (Ando, 2 and 3 immediately after land conversion Khanna and Taheripour 2010). Fuel is a blend (Searchinger et al. 2008). Consumers derive of gasoline and biofuels which can be first or utility from consumption of transportation second generation. The elasticity of substitu- energy and food. Consumer and producer sur- tion is taken to be 2 for the US and 1.55 for plus is maximized given fixed endowments of the EU, respectively (Hertel, Tyner and Birur land. Gasoline and biofuels are imperfect sub- 2010). stitutes; hence, the fuel composition depends Even though several countries (such as upon their relative price. Without regulation, China and India) have adopted biofuel poli- biofuels become competitive as oil stocks cies, we focus on US and EU mandates. US deplete and oil prices increase. The competive- production is supported by a tax credit to ness of biofuels depends upon the demand for blenders of 45 US cents per gallon. This credit food products. Under regulation, the mandate is expected to be withdrawn at the end of 2012.5 imposes a minimum use of biofuels while the A 2.5% ad valorem tariff and a per unit tariff carbon tax increases the price of all fuels (gaso- of 54 US cents per gallon have been estab- line and biofuels) depending on their carbon lished to protect domestic production. In this content. version of the paper, trade barriers are still in Simulations

In the Baseline scenario (BASE), we suppose 3 Oil is also an input in sectors other than transportation, such as in chemicals and heating. IEA (2011) estimates that about 60% that the US and EU mandates are not imple- of crude oil is used in transportation. So we only consider 60% of mented. Next we examine the effects of two total oil reserves as the resource stock available for transport. policy scenarios on the world food and energy 4 One gallon of oil yields 0.47 gallons of gasoline and 0.25 gal- lons of diesel (USDOE). We assume that these coefficients are markets. In the Mandate scenario (called Man- uniform across regions even though refineries may exhibit vary- date), the US and EU biofuel mandates are ing efficiencies in converting crude oil into products. For each region, we consider a representative fuel, e.g., gasoline in the US and diesel in EU. However, in the paper we use the term “gasoline” for all petroleum products. 6 We ran the model after removing the import tariffs, but the 5 Beyond 2012 this tax credit equals zero in our model. results did not change appreciably. 4 Amer. J. Agr. Econ.

Table 2. Effects of Biofuel Policies on Food Table 3. Effects of Biofuel Policies on GHG and Fuel Markets (year 2022) Emissions (in 2022, billion tons CO2) Baseline Mandate Carbon Baseline Mandate Carbon Prices Direct carbon emissions Gasoline price ($/gal) 2.51 2.50 2.52 US 2.04 2.01 2.00 Biofuel price ($/gal) 2.04 2.25 2.27 EU 0.86 0.84 0.83 Food price ($/ton) 638 744 743 World 6.35 6.32 6.31 Gasoline use (billion gallons) Indirect carbon emissions US 123 117 116 World 7.25 11.70 11.75 EU 54 51 50 Total emissions MICs 152 153 154 World 13.60 18.02 18.06 First gen biofuel use (billion gallons) US 7.9 15.0 15.0 EU 1.0 1.8 1.8 second-generation biofuels in the EU in 2022 MICs 8.6 7.2 7.0 (see table 2). In this scenario, 20 billion gallons Second gen biofuel use (billion gallons) of biofuels are used in aggregate globally. US 0.0 21.0 21.0 The consumption of transport fuels in the EU 1.7 3.9 4.0 HICs is quite stable. But it increases sharply Biofuel/gasoline share (%) in the developing countries, up by about 60% US 6.0 23.0 23.0 to 2022. As a result, MICs and LICs become EU 2.9 10.0 10.0 the world’s largest direct carbon emitters by MICs 5.5 4.5 4.0 2030. Because of the combined effect of a Biofuel net exports (million gallons) rise in population and in per capita income, US −597 −1,125 −1,200 food consumption in MICs and LICs also goes EU −4 −90 −91 + + + up by 20%. To meet world food demand, MICs 1,574 2,030 2,035 74 million hectares of land are brought into Land cultivated (million hectares) cultivation by year 2022, which releases sig- World 1,754 1,825 1,828 nificant indirect carbon emissions into the

Note: “Food” implies a weighted basket of commodity prices. atmosphere. Adding direct and indirect car- bon emissions, we conclude that aggregate implemented. In the Carbon scenario (Car- world emissions almost double in this period bon), the above mandates are combined with (2007-2022). a carbon . We impose a time-varying carbon tax of $20/ton CO2 in 2010, gradually Carbon emissions increasing to $39/ton in 2022 (EIA 2009). This tax is based on the allowance price under the A major goal of the mandates is to reduce cap-and-trade provisions of the Clean Energy carbon emissions. In the US and the EU, Security Act. In what follows, we analyze the direct carbon emissions decrease by 1.5% results only for the year 2022. The effect of and 2% respectively (Mandate scenario, see these policies on food and fuel markets are table 3). In both countries, gasoline consump- reported in table 2, while table 3 discusses their tion decreases in favor of biofuels. However, impact on direct and indirect GHG emissions. aggregate fuel consumption rises, hence, GHG emission reductions are fairly modest. Baseline scenario However, GHG emissions decline when the mandates are combined with a carbon tax. The In the absence of any regulation, biofuel con- respective decrease in carbon emissions in the sumption decreases in the US and EU. It is US and EU is 2.0% and 3.5% (Carbon scenario, about 7.9 billion gallons (US) and 2.7 billion see table 3). The carbon tax causes a rise in gallons (EU) in 2022. The respective shares the price of gasoline and biofuels depending on of biofuels in blending fuel are 6% and 3%. their carbon intensities per gallon (see table 2). The only region where the production of bio- Beyond creating incentives to switch to the less fuels is steadily increasing without mandates GHG-intensive fuel, the tax raises the price of is the MICs. We do not observe any second VMT, and hence reduces VMT consumption generation biofuel consumption due to their and GHG emissions. In EU,VMT consumption high costs of production in the US. However, decreases by 2.12% while it is almost stable in more than 50% of biofuels demand is met by the US. Chakravorty and Hubert Global Impacts of the Biofuel Mandate under a Carbon Tax 5

Under both scenarios, direct carbon emis- Table 4. Welfare Gains and Losses in Year sions in the rest of the world rise, the increase 2022 under Different Biofuel Policies (Billions, being more significant under the Carbon sce- constant 2007 dollars) nario. Due to the mandate, the world biofuel price goes up by 10% because the mandates Mandate Carbon force more land into cultivation,which are infe- Food sector rior quality,thus raising the cost of production. US 154 155 Consumers in the rest of the world respond by ROW −450 −449 switching towards gasoline. In the MICs, the Energy sector share of biofuels decreases from 5.5 % under US 51 −23 the Baseline scenario to 4.5 % under the Man- ROW −10,848 −11,325 date. Gasoline consumption decreases by 1% − − while biofuel use is reduced by 16%.As a result, US 90 10 External costs direct carbon emissions in the rest of the world US 0.39 0.39 increase by less than 1%. Under the Carbon ROW −173 −225 scenario, the gasoline price increases while it Net welfare change decreases under the Mandate (see table 2). As US 115 122 a result, the switch towards more gasoline and ROW −11,034 −12,160 less biofuels is more pronounced under the World −11,002 −11,002 carbon tax. Note: The numbers reported are the difference between the surplus under None of the instruments we model succeed the biofuel policy scenario relative to the Baseline. The tax revenue is cal- in significantly reducing indirect carbon emis- culated differently under each scenario. Under Mandate, it is the difference sions. When the mandate is implemented in between the import tariff revenue and the cost of biofuel . Under Carbon, it is the import tariff revenue plus the carbon tax revenue minus the land scarce countries such as the US or the cost of biofuel subsidies. EU, the biofuel target is met by increasing the imports from land abundant MIC nations.7 the mandate is accompanied by a carbon tax, Under Carbon, indirect carbon emissions are the biofuel tax credit is reduced from $1.74/gal higher than under the Mandate scenario. The under Mandate to $1.54/gal under the scenario carbon price instrument improves the com- Carbon. Under the Carbon scenario, because petitiveness of sugar-cane ethanol because gasoline is the dirtier fuel, its price increases gasoline is more carbon-intensive and there- by more than that of ethanol, hence a lower fore becomes relatively expensive. Moreover, subsidy is required to enforce the mandate. ethanol produced in the US gets taxed while The impacts of biofuel policies are regres- imports do not, since they originate from other sive, with richer regions less impacted and the countries. Compared to the Mandate, US bio- poorest hit the hardest under both scenarios. fuel imports from MICs increase. As a result, However, total US welfare increases in both area converted to cropping goes up by an addi- cases (see table 4). In response to the US man- tional 5 million hectares. Indirect and total date, world food prices increase by 17% and emissions are highest under the Carbon sce- world biofuel prices rise by 10%,which benefits nario because in other countries the US agricultural sector. Surplus in the fuel is not subject to the carbon tax. As shown market goes up slightly. The mandate causes a in table 3, the mandates also increase global decrease in the fuel blend price and an increase emissions relative to the no mandate case. in consumption. It thus benefits US consumers. However, US welfare gains are mostly eroded Welfare analysis by the cost of biofuel subsidies required to achieve the target. The cost of the subsidies We calculate regional and world welfare gains net of tariff revenues totals $90 billion dollars. and losses by computing surplus in the food The bulk of the subsidy payments are made in and fuel markets. The absolute changes in sur- order to encourage the use of second gener- plus under biofuels policies compared to the ation biofuels. The benefit from the decrease no-intervention case are reported in table 4. in carbon emissions is almost insignificant (see We first compute the tax-subsidy instrument table 4). When the mandate is combined with to achieve the mandated biofuel use. When a carbon tax, the US agricultural sector also experiences a slight increase in welfare com- pared to the Mandate scenario. However, the 7 Among MICs, Brazil benefits in the export market because it total surplus in the fuel market decreases com- has low biofuel production costs. pared to the Baseline scenario in response to 6 Amer. J. Agr. Econ. the rise in the price of the fuel blend. The loss and in the EU. Consumer welfare is adversely from subsidies is reduced to $10 billion dollars affected by an increase in food prices. In addi- because of the larger revenue from the carbon tion, they suffer from a significant increase in tax (see table 4). indirect carbon emissions. The largest loss in welfare is observed in the Our analysis can be improved to determine MICs and LICs. A rise in energy prices leads to the in the transportation sector. In a loss of surplus in the energy sector. Surplus future work,the disutility of congestion and the from food also goes down. In the MICs and external costs of accidents could be included LICs, a relatively high share of income is spent in our model. According to Parry and Small on food; hence, any rise in food prices impacts (2005), the most important is traf- consumer surplus significantly. This channel is fic congestion. The turns out to be all the more important since price elasticities a rather poor means of controlling distance- for food products are low at lower income lev- related like congestion because it els. The loss in welfare due to carbon emissions is indirect. In response to a rise in the fuel tax, is substantial in the rest of the world. World consumers respond by purchasing more fuel- surplus relative to baseline does not change efficient vehicles rather than driving them less. significantly across the different biofuel poli- A on vehicle miles traveled (VMT) cies. However, the composition of surplus is may perform better. Therefore, an optimal pol- quite different. Under the mandate,the US and icy for transportation may consist of a direct tax EU consumers are relatively better off, while on vehicles miles traveled plus a carbon tax, under the mandate coupled with a carbon tax, which could be modeled in future work. consumers in the US and EU fare poorly. Con- sumers in developing countries are adversely affected by the mandate and are slightly less References worse off under the combined mandate plus tax policy. Ando, A.W., M. Khanna, and F. Taheripour. 2010. “Market and Social Welfare Effects of the Renewable Fuels Standard,” in M. Conclusion Khanna, J. Scheffran, D. Zilberman (Eds), Handbook of Bioenergy Economics and We analyze the effects of biofuel policies on Policy, Chapter 14, New York: Springer. carbon emissions and welfare. The policies Chakravorty, U., M-H Hubert, M. Moreaux, considered include the US and EU mandates and L. Nostbakken. 2012. “Will Biofuel accompanied by a biofuel subsidy or by a Mandates Raise Food Prices?” Unpub- carbon tax. GHG emission reductions are lished manuscript, University of . quite modest in size when biofuel mandates Chen, X., H. Huang, and M. Khanna. 2012. are implemented. The price of blending fuel “Land Use and Impli- decreases in the regulated countries, which cations of Biofuels: Role of Technol- increases energy use and thus, GHG emissions ogy and Policy” Available at SSRN: do not decline. When the mandate is accom- http//ssrn.com/abstract=2001520. panied by a carbon tax, the price of gasoline de Gorter, H. and D. Just. 2009. “Economics and biofuels both increase depending on their of a Blend Mandate for Biofuels” Amer- respective carbon intensities. By raising the ican Journal of Agricultural Economics, cost of both fuels, the carbon price instruments 91(3):738–50. lead to a rise in the price of the fuel blend EIA. 2009. “Energy Market and Economic and a decrease in carbon emissions. How- Impacts of H.R. 2454, the American ever, the domestic reduction in GHG emis- Clean Energy and Security Act of 2009.” sions achieved by the biofuel policies (mandate SR/OIAF/2009-05, Energy Informa- plus carbon tax) is eroded by larger indirect tion Administration, Office of Integrated carbon emissions, in other countries. Indirect Analysis and Forecasting,U.S. Department carbon emissions are higher when the man- of Energy,, DC. date is implemented along with a carbon tax. EIA. 2011. International Energy Statistics. The carbon tax increases the competitiveness U.S. Energy Information Administration of imported biofuels from MICs. As a result, Washington D.C. more marginal lands are brought into cultiva- Eisentraut, A. 2010. Sustainable Production tion. In terms of welfare effects,poorest regions of Second-Generation Biofuels: Potential are most impacted by the regulation in the US and perspectives in major economies and Chakravorty and Hubert Global Impacts of the Biofuel Mandate under a Carbon Tax 7

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