Dixon, Peter; Osborne, Stefan; Rimmer, Maureen --- "Could biomass fuels ever replace crude?" [2007] MonashBusRw 28; (2007) 3(2) Monash Business Review 19

Could biomass fuels ever replace crude?Peter Dixon, Stefan Osborne, Maureen Rimmer

An important objective of President Bush’s energy policy is to cut US reliance on imported crude oil. The policy calls for research to reduce the costs of alternative fuels. In June 2006, the US Department of Commerce commissioned Monash University’s Centre of Policy Studies (CoPS) to estimate the effects on the US economy of a successful research program that allows substantial replacement of imported crude oil with domestically produced biomass fuels such as ethanol. Peter Dixon and Maureen Rimmer from CoPS joined Stefan Osborne from the US Department of Commerce to illuminate the benefits.

The United States’ capacity to produce crude oil domestically peaked during the 1970s. Crude oil imports exceeded 50 per cent of domestic consumption by 1994, and 65 per cent by 2004. The President’s current energy policy aims to reduce US reliance on imported crude oil. But at its present cost, biomass alternatives, like ethanol, are not competitive with average gasoline prices expected in the long run. Subsidies from the US Government for biomass fuels research aim to address this.

With current technologies, the cost of making biomass-based motor fuel (cellulosic ethanol) is about $US2 per gallon. Since ethanol has about two thirds the energy of gasoline, the cost of replacing one gallon of gasoline with ethanol is about $3 per gallon. When crude oil prices are at $US40 per barrel (as they were in 2004), gasoline is about $US2 per gallon. Thus the assumption of cost competitiveness in 2020 at 2004 prices implies a reduction of 33 per cent over the next 13 years in the cost of biomass-based motor fuel relative to petroleum-based fuel. This isn’t an overly ambitious target as the cost of cellulosic ethanol has fallen from about $US6 per gallon in 2001 to $US2 per gallon.

Assuming that ethanol becomes competitive at 2004 prices and that it replaces 25 per cent of US consumption of crude oil, then USAGE (see box) results show major gains for the US economy by 2020.

Crude oil imports to the United States average about 10 million barrels a day. Oil and other imported petroleum products cost the US about $US300 billion a year. This is 13.5 per cent of the US import bill.

Macroeconomic effects

• The macro effects in 2020 of the adoption of 25 per cent, cost-competitive biomass fuel include:

• Increases in private and public consumption of 0.363 and 0.368 per cent over the levels they would be without the adoption of biomass fuel

• Increases in post-tax real wage rates of 0.412 per cent

• An increase in real GDP of 0.158 per cent.

• Applied to the economy of 2004, these effects are equivalent to:

• An increase in consumption (combined private and public) of $US36 billion or about $US120 per person

• An increase in the real post-tax wage rate of about $US206 a year for people on average wages

• An increase in real GDP of about $US18 billion.

• These are much larger gains than usually associated with microeconomic changes.

• The four factors that contribute to these gains are:

• Costs-saving substitution between inputs in the production of motor fuels

• A reduction in the world price of crude petroleum

• 35,000 extra jobs in agriculture in 2020

• Higher US export prices because a lower import bill means fewer exports are needed to pay for imports.

Industry effects

A biomass policy would increase crop output in 2020 by 17.54 per cent and have strong positive effects on industries such as farm machinery, fertiliser and cordage and twine. It would also raise the exchange rate making international travel for US residents cheaper. This is good for the foreign holiday industry (the industry that organizes foreign holidays for US residents). However, industries like prepared feeds, wet corn mills, leather tanning and animal agriculture industries will be harmed by increases in the costs of crop agricultural products. Industries involved in US oil production lose from the biomass policy because of lower oil prices. However, US production of motor fuels (ethanol and gasoline) increases under the policy, reflecting lower costs of their inputs.

Are the modelling results robust?

There are two main assumptions underlying the CoPS modelling. The first is that the US will be able to produce sufficient biomass to replace 25 per cent of crude oil. The second is that ethanol will become competitive with gasoline at 2004 prices.

Some officials in the US Departments of Agriculture (DOA) and Energy (DOE) think that the US will not have enough biomass and that the ethanol cost assumptions are too optimistic.

Twenty five per cent replacement will require about 80 billion gallons of ethanol in 2020. The DOE target is to increase the yield of cellulosic ethanol production from about 65 gallons per dry ton to 90 gallons. Eighty billion gallons of ethanol will require about 900 million dry tons of biomass in 2020 which is consistent with a best-case scenario presented in DOE/DOA.

If only 450 million dry tons of biomass are available in 2020 (a rather pessimistic assumption) then replacement will be restricted to 12.5 per cent and USAGE calculations show that the benefits will be about half those calculated for the 25 per cent case.

If the cost target for ethanol is not met, then there is surprisingly little drop off in benefits. For example, if ethanol becomes competitive only at an crude oil price of $ US50 a barrel instead of $US40 a barrel, then the gain in US consumption from 25 per cent replacement in 2020 falls from $US36 billion to a still hefty $US29 billion. Even if ethanol is not highly competitive, replacement of crude oil by biomass will still generate gains for the US from reduced world oil prices, increased agricultural employment and improved prices for US exports.

Biomass benefits

The Centre of Policy Studies (CoPS) at Monash University has used the USAGE model to analyse the benefits to the US from a research program that leads to cost-competitive biomass fuels, predominately ethanol. USAGE is a 500 industry, dynamic model of the US developed at CoPS in collaboration with the US International Trade Commission. In the modelling CoPS assumed that ethanol becomes competitive with gasoline at the prices of 2004 (when oil was $40 a barrel).

CoPS assumes that this allows domestically produced ethanol to replace 25 per cent of US crude oil consumption by 2020. The USAGE modelling quantifies four benefits from this replacement:

1. Costs-savings

In the US Department of Energy benchmark out to 2020, adopted in USAGE, the price of crude oil increases sharply relative to the overall price level. By contrast, the USAGE benchmark price of biomass products declines relative to the overall price level, reflecting continuing rapid productivity growth in agriculture. If research makes ethanol competitive with gasoline at 2004 prices, then ethanol will be super-competitive at 2020 prices.

2. A reduction in the world price of crude oil

The US accounts for about a quarter of world consumption of crude oil. The assumed substitution of biomass for crude oil has a noticeable damping effect on world demand for crude oil, generating a reduction in its price.

3. An increase in aggregate employment

Biomass substitution generates a strong long-run increase in agricultural employment. This will have the effect of keeping farmers in work who otherwise would have retired or would have worked their farms less intensively.

4. An increase in export prices

Biomass substitution means that the US will have a smaller import bill – a reduced volume of crude oil imports at a reduced price. With a smaller import bill, the US will need fewer exports to pay for its imports. Foreign demand curves for US exports slope downwards, implying that foreigners will pay higher prices when US supply contracts.

Data was analysed using USAGE, a 500 sector dynamic Computable General Equilibrium (CGE) Model of the US economy developed over six years at CoPS in collaboration with the US International Trade Commission.

Table 1 What happens when you replace crude petroleum inputs with biomass

Table 2 The motor fuels industry: inputs and outputs in current dollars

Table 3 The motor fuels industry: inputs and outputs, percentage shares

Table 4 Effects on industry outputs in 2020 of replacing 25% of crude petroleum with biomass

This paper is based on a fuller version due to be published in Vol 18 No 5 of Energy & Environment, Multi-Science, Brentwood, 2007. Energy & Environment have kindly given permission for publication of this abridged version.

Cite this article as

Dixon, Peter; Osborne, Stefan; Rimmer, Maureen. 'Could biomass fuels ever replace crude?'. Monash Business Review. 2007.; Monash University ePress: Victoria, Australia. http://www.epress.monash.edu.au/. : 19–23. DOI:10.2104/mbr07028

About the authors

Peter Dixon

Peter B. Dixon is a Sir John Monash Distinguished Professor in the Centre of Policy Studies, Monash University.

Stefan Osborne

Dr Stefan Osborne is an economist with the US Department of Commerce.

Maureen Rimmer

Dr Maureen T. Rimmer is a Senior Research Fellow in the Centre of Policy Studies, Monash University.