BIOMASS INTEL

Despite a generous carve out from the EPA’s RFS2, the biodiesel industry is hurting right now.

The expiration of a $1 tax credit in 2009 removed a key guarantor of price competitiveness with petroleum diesel.  Although the House has passed a bill to extend the credit, the biodiesel tax incentive has been written into at least three Senate bills since November, but has yet to reach a floor vote.  Recent efforts to revive the credit by Senators Baucus (D-MT) and Grassley (R-IA) have been buried by health care, record snowfall in Washington, and a Reid (D-NV) rewrite of the Jobs bill.

As a result, many plants throughout the U.S. have either shut down or stand idle.  Biodiesel Magazine reports that some have tried to pass the now-additional $1-per-gallon cost for biodiesel along to customers, but have failed to gain traction in the market.

Even so, a broader question remains: with the EPA’s new renewable fuel standard (RFS2) in place, is a subsidy even necessary?

Robert Rapier writing about ethanol tax credits in “the redundant subsidy,” argues:

With ethanol mandates now in place in the form of the Renewable Fuel Standard (RFS), there is a mechanism – with penalties for non-compliance – to ensure that gasoline blenders use the mandated amount of ethanol.  Maintaining a subsidy on top of a mandate would be like paying people to obey the speed limit.

This view suggests that mandates under the RFS2 for renewable fuels are sufficient to stimulate biofuel and biodiesel market demand.  To explore whether this is actually the case, a quick look at how alternative fuel mandates work from Harry de Gorter & David R. Just writing in the American Journal of Agricultural Economics:

The RFS is enforced by a trading credit scheme administered by the U.S. Environmental Protection Agency (EPA), tying together biofuel producers with refiners, exporters, and blenders of oil-based gasoline.  Biofuel producers and importers generate renewable identification numbers (RINs) with each gallon of biofuel they produce.  This RIN credit is transferred whenever the biofuel is sold to blenders or refiners.  The RIN credit can be used by fuel blenders as evidence of compliance with the RFS.  If the blend exceeds the RFS, then they can sell (i.e., trade) their excess RINs to other obligated parties who can now blend biofuels at a rate below the RFS (EPA 2008).  The EPA therefore verifies the correct number of RINs for the total quantity of fuel blended…Each firm must meet or exceed the blend requirement on each sale unless RINs are purchased from firms willing to exceed the requirement.

The effect of a mandate can be to either increase or lower biofuels prices depending on demand-elasticity of oil and diesel.  In other words, mandates won’t necessarily stimulate biodiesel markets.

Writing in Applied Economics Perspectives and Policy (AEPP), the Gorter & Just note:

Adding a biofuel subsidy with a consumption mandate fails to increase ethanol consumption but instead subsidizes oil consumption.  A more effective policy would rely on specific taxes and subsidies targeted directly at achieving specific environmental, energy, and agricultural policy goals.

With opinions mixed on the matter, the subsidy-less biodiesel market will be an interesting experiment for U.S. policy makers, unfortunately one that will come at the expense of a projected 23,000 biodiesel industry jobs.

Image: Flickr/pinkcigarette