Are Rising Oil Prices Really Good for the Biofuel Industry?

by | May 12, 2011

At face value, the recent runup in the price of petroleum, caused by political instability in the Middle East and related factors, would seem to be a boon for the future of biofuel. Currently, the U.S. price of oil is hovering around $100 per barrel, the level at which it is said ethanol becomes commercially competitive with it. This has sparked renewed discussion of U.S. energy independence, a central theme in the latest State of the Union address. The Environmental Protection Agency has approved raising the allowable percentage of ethanol in gasoline in newer cars from its previous level of 10% to 15%.  According to the Department of Agriculture, refiners will produce an estimated 13.5 billion gallons of ethanol in 2011, more than six times the amount produced in 2002. Indeed, the U.S. is projected to export up to one billion gallons of ethanol this year. Fully one third of the American corn crop is now used for the production of ethanol. Thus it would appear that these are rosy times for the biofuel community — correct?

As with any topic that involves global economics, the real situation is much more complicated. And however ironic it may seem at first, rising oil prices actually present at least two very significant challenges to the biofuel industry, challenges that it will need to address before long to ensure continued future growth.

Fuel and Food: The Cost Connection

Modern agriculture is heavily reliant on petroleum. Today’s large scale farming is highly mechanized, especially within the “factory farms” that produce the majority of U.S. bulk crops. High end farm machinery, along with the vehicles required to transports crops, all consume large quantities of fuel. As the price of this fuel rises, the additional cost is factored into the price consumers must pay for produce, including corn and other biofuel feedstocks.

Making matters worse, a large percentage of the fertilizers, pesticides, and herbicides used by high-tech agriculture is also derived from petroleum (and are energy-intensive to produce). These chemicals have become critical tools that allow farmers to maintain their high productivity. Non-petroleum alternatives to these chemicals may eventually be developed; but in the near term these products will continue to be used to ensure the world’s ability to feed itself is not compromised, thereby creating another direct connection between the price of oil and the cost of food.

History has clearly demonstrated this link. For instance, between July 2007 and June 2008, crude oil rose from $75 per barrel to $140, while during this same period the Food Price Index (a metric that monitors the relative cost of basic food staples) rose from approximately $160 to $225. This simultaneous increase in fuel and food has been cited as a major contributing factor in the recent global recession. More recently, the cost of food has again risen alongside that of oil, with corn prices spiking to a three-year high. This means that corn ethanol producers will now have to pay more for their raw material, resulting in a higher price for their product. During March of this year, the cost of a gallon of ethanol in the U.S. climbed from $2.30 to $2.70, a whopping 17% in a single month. Such a rise in price will negate at least a portion of the positive impact that more expensive oil might otherwise have on the biofuel industry.

Political Fallout
Perhaps even more detrimental to the well-being of the biofuel community is the political and social aspects of rising food prices. There’s been increasing criticism of using corn and other feedstocks for the production of biofuels during a period when many are finding it more and more difficult to afford to feed themselves. Recently, Peter Brabeck-Letmathe, Chairman of multinational giant Nestle, sharply criticized U.S. policies and incentives to promote biofuel production. He pronounced them “absurd” and “absolutely immoral,” reducing the supply of corn that can be used as food (either directly, or indirectly as animal feed) and therefore pushing “hundreds of millions of people into hunger and into extreme poverty.” In less vitriolic terms, the World Bank estimates that every time oil jumps $1, there’s a 90 cent increase in corn, “because every dollar increase in the price of oil increases the profitability of ethanol and hence biofuel demand for maize.”

Rising food prices can have extremely serious consequences, as recent events prove. Many have attributed the current unrest in Middle Eastern countries (as well as other countries such as Haiti and Pakistan) to the general population’s outrage over the high cost of food. Ironically, this unrest has led directly to higher oil prices — which as we’ve noted earlier, produces a commensurate rise in food costs, creating the potential for a spiraling situation in which food prices prompt more disorder, which prompts higher oil prices, and so on until breakpoint levels are reached.

Given this environment, many find it difficult to justify placing further demands on the food supply by using potentially edible feedstocks to produce biofuel. This may place a serious damper on the public’s enthusiasm for biofuel as an energy source, significantly reducing the commercial viability of this sector.

Biofuel Challenges

Many readers may question this article’s focus on ethanol — after all, there are plenty of other potential types of biofuels, many of which do not use corn or other edible feedstocks and therefore do not produce the same impact on global food supplies. Nevertheless, ethanol serves as an instructive example for virtually any biofuel that will be produced in the high-volume quantities necessary to supply a significant percentage of the world’s energy needs. For example, any land-based feedstock crop grown specifically for biofuel production will likely be produced by large scale farming methods that rely on petroleum-based products (such as fertilizers) to maximize per-acre yields, and fuels to power machinery and transportation vehicles. Biofuels manufactured from natural sources such as algae, or non-crop materials such as wood chips or waste biomass, require energy-intensive production processes and transport vehicles to move feedstock into (and product out of) their manufacturing facilities. Thus any large-scale manufacture of biofuel of any variety will likely be subject to the same oil price fluctuations as ethanol currently is (although perhaps to a less extent in some cases).

One way around this reliance on petroleum may be to build biofuel production facilities near their sources of non-crop feedstocks, and use the finished product locally. Although this may satisfy relatively small scale regional needs, it’s unclear whether or not there are enough such feedstock sources to produce energy on the scale needed to substantially reduce America’s overall reliance on oil.

No one should conclude that higher oil prices are necessarily bad for the biofuel industry — obviously, they represent a very important commercialization driver, one that has attracted interest (and funding) to a variety of possible biofuel types and production methods. However, it should also be recognized that more expensive petroleum also raises significant challenges to biofuel. Addressing these challenges (and thereby breaking the industry’s current heavy reliance on petroleum products) will likely be necessary before biofuel can assume its place as a significant component of America’s energy independence strategy.

Dick McCarrick is an analyst with Foresight Science & Technology.

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