Biodiesel, Petroleum Diesel and Free Markets

By: Mark Vermeer – March 2008
Source: BIODIESEL MAGAZINE

Many politicians and free-market advocates have a disdain for mandates or subsidies for biofuels and maintain that free-market economics should determine their use. I was born and raised in Iowa and have lived there my entire life, so I have a stake in Iowa and correspondingly in biofuels since Iowa is the largest biofuels-producing state in the nation.

However, like the free-market advocates, I also believe in free trade and minimal government involvement. Therefore, I am conflicted and find myself agreeing with those who do not believe in government subsidies and mandates for biofuels.

The presidential candidates were interviewed by the Des Moines Register for its Dec. 16, 2007, feature insert "Fueling Iowa's Future" concerning their respective stances on subsidies and mandates for biofuels. Surely it would have been politically "expedient" for all of the candidates to respond to that query with what most Iowans probably want to hear, that biofuels should be subsidized or mandated. It's hard not to respect the fortitude and integrity of candidates John McCain and Ron Paul (and then-candidate Fred Thompson) who didn't buckle under the question and in my opinion gave the right answer, which is: Do not subsidize biofuels and let them stand on their own.

However, if one argues that biofuels should not be subsidized, then petroleum fuels shouldn't be subsidized either. It sounds good to say that biofuels should be able to stand on their own in a competitive free market, but the problem with that argument is that government created the subsidies for petroleum fuels. After decades of a status quo energy policy, even after the wakeup call with the OPEC oil embargo in the early 70s, those subsidies are so ingrained in federal, state and local energy infrastructures that they're virtually impossible to quantify, much less eliminate.

This editorial is about biodiesel. Granted, ethanol has received its fair share of criticism and people have tried to downplay its role in energy policy, but let's be honest, ethanol is the poster child for biofuels and doesn't need the advocacy that biodiesel does. The fact that ethanol is blended into gasoline and therefore directly affects consumers and that it has been around a lot longer makes it more widely understood and accepted. Biodiesel, on the other hand, is blended into the diesel that fuels commerce and industry and therefore indirectly affects consumers.

The real cost of diesel fuel could be at least twice as much as what we pay. An indication of this is the disparity between the price of diesel fuel in Europe and the price in the United States. Diesel costs at the pump in places in Europe is more than double what it is in the United States. Here are some ways in which petroleum diesel fuel is subsidized because these costs are not factored into its price:

The cost of the trade deficit: The United States imports 4.75 billion barrels of diesel fuel per year at a cost of $450 billion
The cost of preferential tax treatment that oil companies receive
The cost of maintaining the Strategic Oil Reserve, and federal, state and local distribution infrastructure
The cost of government-assisted exploration and research
Environmental and health costs associated with vehicle exhaust
Military cost.

Feedstock oils for biodiesel are at historically high prices, yet biodiesel cannot pass on its feedstock cost as petroleum fuels are able to do. With vegetable feedstock oils exceeding 50 cents per pound ($3.75 per gallon), the cost to produce biodiesel is more than $4 per gallon. Obviously, with petroleum diesel retailing for $3.30 per gallon and biodiesel wholesaling at well over $4 per gallon, biodiesel cannot compete unless subsidies are removed from petroleum diesel, or biodiesel is subsidized.

Since it is not realistic to believe that petroleum fuel subsidies are going away any time soon, the argument I am making is simply that if biodiesel is not going to be subsidized, then it should be considered a premium diesel additive and therefore worth more than petroleum diesel. Besides reducing by more than 70 percent the components of diesel exhaust that adversely affects respiratory health, biodiesel is a low-sulfur diesel fuel lubricity replacement. This is important because with ultra-low sulfur requirements now in effect, taking the sulfur out of diesel fuel also removes lubricity which is absolutely essential to engine performance. Of course, biodiesel reduces our trade deficit and does not carry the other costs associated with petroleum fuels.

Unless fuel companies are mandated to put biodiesel in diesel fuel, they have no incentive to pay more for it. There is no question that in the future consumers will end up paying more for energy and transportation fuel, but cleaning up the environment and reducing our oil imports is going to come at a price. We have had cheap energy ever since the first oil well was drilled so there has to be a paradigm shift with regard to what transportation fuel "should" cost. Biodiesel is a lower-cost solution than is imposing the true cost of petroleum diesel.

There is, however, another solution: a carbon tax on energy sources that emit carbon dioxide. This is an example of a pollution tax, which some economists favor because they tax a "bad" rather than a "good" (such as income tax). The purpose of a carbon tax is environmental, to reduce emissions of carbon dioxide and thereby slow global warming. It can be implemented by taxing the burning of fossil fuels—coal, and petroleum products such as gasoline, diesel, aviation fuel and natural gas—in proportion to their carbon content. Unlike market-based approaches such as carbon cap-and-trade systems, it has the benefit of being easily understood and can be popular with the public if the tax is hypothecated to fund environmental projects. Diesel fuel emits 22.384 pounds of carbon dioxide per gallon, so a tax of $100 per ton of carbon dioxide emission translates to a tax of $1.119 per gallon of diesel fuel. Our $3.30 per gallon diesel fuel now becomes $4.50 per gallon.

When biodiesel feedstock costs drop from their current level of 53 cents per pound ($4 per gallon) for refined soybean oil to less than 40 cents per pound ($3 per gallon) for future feedstocks that will more than likely be something other than refined soybean oil and petroleum diesel retails at $4.50 per gallon, biodiesel no longer needs a subsidy (currently the $1-per-gallon excise tax credit) to be competitive. It is conceivable, however, feedstocks for biodiesel could be developed that cost far less than even 40 cents per pound, possibly reaching 30 cents per pound ($2.25 per gallon). Add production costs (50 cents per gallon) and state fuel taxes (50 cents per gallon) making the retail cost of biodiesel $3.25 per gallon, and the petroleum diesel scenario of $4.50 per gallon, biodiesel not only does not need to be subsidized, it actually lowers the pump cost of diesel fuel.

Nothing happens with energy policy because it is too painful to face the reality that we have had cheap energy for so long. Transportation energy costs will go up with or without biofuels. At least with biofuels some of the impact to the economy will be offset by 1) the creation of an entire industry with good-paying jobs, 2) a decrease in the national trade deficit, 3) a decrease in health-related costs, 4) a decrease in the costs imposed by natural catastrophes caused by global warming, 5) a decrease in the costs associated with military global intervention, and 5) other benefits to the economy. The discovery of other renewable feedstock sources and the technology to convert them to transportation fuels, such as cellulose for ethanol and algae for biodiesel, might actually cushion the rise in energy costs.

If biodiesel is going to be part of the solution to our future energy challenges, then now is the time to act, because high feedstock costs are killing biodiesel producers. Killing those pioneers, entrepreneurs and investors who took the risk to make biodiesel what it is today, is not the American way.