Is the End in Sight for EU Biofuels Policy?

September 14, 2012 § Leave a comment

By Prof. Rob Ackrill, Nottingham Business School

Biofuels are, without doubt, controversial. So the recent leak of a draft proposal for a revision of EU biofuels policy has attracted much attention. But even if legislation were to resemble the draft proposal (a big ‘if’), would that be a U-turn, the EU abandoning biofuels, as some headlines suggest? The answer, I believe, is ‘more no than yes’. Supported by the UKs Economic and Social Research Council I, and my colleague Dr Adrian Kay of the Australian National University, have studied biofuels policies for several years. Here is my personal take on what I have read; admittedly, only second-hand articles – I have not seen the leaked draft.

First, some background and context. Why biofuels? Transport emissions are predicted to be the largest source of increases in greenhouse gas (GHG) emissions in future. Biofuels have the potential to reduce these emissions, as they can substitute for higher GHG-emitting fossil fuels. The current legislation (principally the 2009 Renewable Energy Directive) requires that, by 2020, 10% of transport fuels should come from renewable sources. Most of this (one recent estimate is 8.9%) is expected to come from biofuels.

Biofuels, in this context, refer to ethanol and biodiesel, the former derived from sugars (not only sugarcane and beet, but also the sugars in, for example, maize and wheat), the latter from oils. Currently, 99% of biofuels produced globally are ‘conventional’ or ‘first generation’. These are derived from inputs (or ‘feedstocks’) which also have food or animal feed uses. While globally ethanol dominates, in the EU biodiesel is important in both production and consumption.

As for advanced biofuels, a common distinction is between second generation biofuels (based on non-food biomass, eg wood waste or grasses), third generation (algae), and fourth generation (created by ‘lab-based’ processes). Current EU policy, in an attempt to encourage the production of advanced biofuels, counts them ‘double’ towards the 10% figure. Why? Because conventional biofuels have potential downsides.

It is possible that, by diverting feedstocks from food uses, food prices could rise. As well as being a problem in itself, this could encourage farmers to bring land into agriculture that was not used previously to produce food. This – known as Indirect Land-Use Change (ILUC) – is controversial, first, because it implies biofuels could trigger deforestation, the draining of wetlands, higher GHG emissions, etc. Second, ILUC cannot be seen directly, only estimated by economic models. Unfortunately, because we still have only partial understanding of ILUC dynamics, scientists still disagree over its magnitude. The reality is that there are multiple causes of high food prices, starvation, deforestation, etc. To blame all, or even a significant portion, of this on biofuels is potentially very misleading. One article reporting on the leak indicated EU policy could possibly cause a shift in land use equivalent to the area of Denmark. It is also an area equivalent to 0.09% of world agricultural area, a fact which will limit its market impacts, even as a worst case scenario. Another modelling challenge (I say more on this later) is that almost every biofuels feedstock-technology combination produces a different GHG emissions performance.

In an attempt to limit the impact of biofuels on food prices and ILUC, the draft proposal limits the contribution conventional biofuels can make to the 10% target. Is this a U-turn. Not really. The reason, ironically, is in the current legislation. From 2017, the GHG emissions savings that biofuels must deliver is set to rise sharply. The current targets are already a challenge for some conventional biofuels. From 2017, unless there are major technological breakthroughs, many of the biofuels currently eligible will cease to be eligible. It is important to recognise that the EU (and the US) use mandates to help provide certainty for investors and firms in the biofuels industry. Given the policy change in 2017 and the uncertainty it creates, the leaked draft would help reduce that uncertainty. By setting a clear limit on conventional biofuels, more potential demand for advanced biofuels is created. This, in turn, should encourage more investment in an industry which, currently, remains small.

Another aspect of the proposal is the ending of public subsidies for crop-based biofuels after 2020. First, such a move would merely follow recent US policy. There, however, maize (‘corn’) ethanol is able not only to compete on price with fossil fuels but, given high oil prices, is helping reduce the price of gasoline at the pumps (recent estimates have ranged from about 50 cents to over $1 per gallon). EU biofuels production, however, is on average and in general, not as competitive. The EU must also import biofuels, given limited EU biofuels production relative to the mandate. If the proposed change resulted in lower EU production this, paradoxically, could enhance the credibility of EU policy, given the poor relative emissions and market impacts of EU-produced biofuels compared with (some) imported biofuels. Given the relative importance of biodiesel in the EU transport biofuels mix, there remains a considerable challenge to ensure imported biodiesel is not produced on land that was previously rainforest or wetland – but, again, the changes already planned for 2017 will have a considerable impact here anyway.

As I have already said, different biofuels produced in different ways deliver different GHG emissions-savings. The best biofuel is Brazilian sugarcane-ethanol. It has outstanding GHG-reductions performance and is subject to very tight planting controls (the agro-ecological zoning scheme). If the final legislation was applied simply to all food-based biofuels, this would be excluded. That I find inconceivable. As policy-makers told me in Brasilia, in sugarcane-ethanol, Brazil has a conventional biofuel with advanced biofuels performance.

In conclusion, removing public subsidies for conventional biofuels would an important policy development, but since the aim of EU policy is to establish a fully-functioning biofuels market, the removal of subsidies to conventional biofuels could be seen simply as part of that evolving process. The limit on conventional biofuels in the blend mandate could actually improve the credibility of EU biofuels policy, as it may well deliver an improved environmental impact overall. I would also expect to see any legislation accommodating, for example, Brazilian sugarcane ethanol. One thing is certain – the death of EU biofuels policy has most definitely been exaggerated.

Further Reading: two recent papers written by Adrian Kay and myself

A working paper can be found at:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2095987

 “Sweetness and Power – Public Policies and the Biofuels Frenzy” is forthcoming in EuroChoices, a policy-oriented academic journal:

http://www.blackwellpublishing.com/journal.asp?ref=1478-0917

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Inheritance has a concave effect on the hours worked by British male entrepreneurs

November 20, 2011 § Leave a comment

Author: Dr. Zhongmin Wu, Nottingham Business School

Using data from the British Household Panel Survey (1998 – 2009), Faria and Wu (2012) find that inheritance has a concave effect on the hours worked by male entrepreneurs. Receiving inheritance increases the labor supply of British male entrepreneurs; however this effect becomes smaller for higher inheritances, eventually turning negative.

Does inheritance create a disincentive to labor? According to the Carnegie conjecture, the greater the inheritance, the lower the recipient’s labor supply. The usual explanation is that inheritance negatively affects the marginal utility of wealth, regardless of whether the inherited wealth is anticipated or not.

Faria and Wu (2012) estimate the labor supply function of nascent entrepreneurs who were unemployed last year. The data used for this research is the British Household Panel Survey (BHPS) from wave 8 to wave 18 (1998 – 2009). The endogenous variable of the model is “Self employed: hours normally worked per week”. The results show that inheritance has a concave effect on the hours worked by male entrepreneurs. This is an important result as it implies that receiving an inheritance has a significant impact on one’s transition from unemployment to entrepreneurship. Receiving an inheritance increases the labor supply of British male entrepreneurs; however this effect becomes smaller for higher inheritances, eventually turning negative. The nonlinear effect peaks on an inheritance value of £41,254, which increases self employed hours worked per week by 8.3 hours (see figure). The results are robust and consistent.

References:

Faria J. and Wu Z. (2012) From Unemployed to Entrepreneur: The Role of the Absolute Bequest Motive, Economics Letters, 114 (1), 120 – 123

Figure 1

Frank Benford’s Fascinating Law of Anomalous Numbers

November 20, 2011 § Leave a comment

Author: Prof. Leighton Vaughan Williams, Nottingham Business School

In a fascinating article published in the New York Times, a certain Malcolm Browne relates how Dr. Theodore Hill would ask his maths students to go home and either toss a coin 200 times and record the results, or else pretend that they had done so. Either way, he would ask them to produce for him the results of their (real or imaginary) coin-tossing experiment.

Dr. Hill’s purpose in this experiment was to show just how difficult it is to fake data convincingly. It just isn’t that easy to make up a random sequence. Based on this knowledge, he would astound his students by almost unerringly picking out the fakers from the tossers!

One of the ways he would do this would be to spot how many times heads or tails would be listed six or more times in a row. In real life, this occurrence is overwhelmingly probable in 200 coin throws. To most of his students this long a sequence is counter-intuitive, an example of what is often termed the Gamblers’ Fallacy, i.e. the erroneous perception that independent random sequences will balance out over time, so that for example an extended sequence of heads is more likely to be followed by a tail than a head. The fakers, susceptible to the Fallacy, are thus easily exposed. Ordinary people, even mathematics students, simply can’t help introducing patterns into what is random noise.

This is an example of a broader analysis which is usually referred to a Benford’s Law, which essentially states that if we randomly select a number from a table of real-life data, the probability that the first digit will be one particular number is significantly different to it being a different number. For example, the probability that the first digit will be a ‘1’ is about 30%, rather than the intuitive 10%, which assumes that all digits are equally likely.

The empirical support for this proportion can be traced to the man after whom the Law is named, physicist Dr. Frank Benford, in a paper he published in 1938, called ‘The Law of Anomalous Numbers’. In that paper he examined 20,229 sets of numbers, as diverse as baseball statistics, the areas of rivers, numbers in magazine articles and so forth, confirming the 30% rule for number 1. For information, the chance of throwing up a ‘2’ as first digit is 17.6%, and of a ‘9’ just 4.6%. The same principle applies to trailing (i.e. last) digits. It’s a great way, therefore, of checking the veracity of receipts. If, for example, there is an unusual number of trailing digit ‘7’s, there’s a decent chance that the figures are cooked. Tax authorities are alert to this.

Which makes fraudulent activity just that little bit easier to detect. For all right-minded citizens, let’s call that Benford’s Bonus.

Links:

http://www.rexswain.com/benford.html

http://www.jstor.org/pss/984802

Can Orange Juice Help Forecast the Weather?

November 16, 2011 § Leave a comment

Author: Prof. Leighton Vaughan Williams, Nottingham Business School, Nottingham Trent University.

Can Orange Juice Help Forecast the Weather?
Well over 90% of all US oranges used in frozen concentrated orange juice are grown in central Florida. The reason is that oranges grown in central Florida produce better concentrated orange juice than oranges grown in California, the other major source of oranges in the US.
Clearly this makes the weather in central Florida of critical importance to the market price of orange juice. One would expect, therefore, that the weather forecast for central Florida should be a key factor influencing the price at which orange juice futures trade. That’s one thing. But what now if we phrase the issue in reverse? Can we use these orange price futures to actually forecast the weather? And if so, how well do forecasts so obtained compare with the forecasts issued by the official National Weather Service?
A study carried out by Professor Richard Roll of the Graduate School of Management at the University of California sought to find out. In the resulting research paper, called “Orange Juice and Futures”, published in the American Economic Review in December 1984, Roll found what he termed a “statistically significant relation between OJ returns and subsequent errors in temperature forecasts issued by the National Weather Service for the central Florida region.”
In particular, if the closing orange juice futures price is higher than its opening price, we would obtain a more accurate prediction of the weather by adjusting downward the National Weather Service’s weather forecast. This is because a higher futures price implies a smaller crop and colder weather. Correspondingly, if the orange juice futures price is lower than its opening price, we should adjust upwards.
A front-page article in Florida’s St. Petersburg Times, on Monday, October 17, 1983, puts this in some perspective. “The National Weather Service spends $280 million each year predicting the nation’s weather,” it runs, “and it uses some of the niftiest gadgets … to do it. But it may be overlooking the price of orange juice.”
In an interview with the paper, Roll noted how in 1981, when the temperature in central Florida fell into the 20s (Fahrenheit) for four consecutive nights, the price of orange juice futures rose 40%. “They [the traders] have their own meteorologists”, he explained. “They have a bigger incentive than the Weather Bureau itself to predict it correctly.” In particular, if traders can anticipate falling temperatures they can buy before the price goes up and sell after it does.
An important point to note here is that nobody is saying that the official weather forecasting service is of no value. Indeed, the market might have been a lot less accurate if these forecasts didn’t exist. What Roll’s study does suggest, however, is that the commodity markets add some information above and beyond this, much as opinion polls can help forecast election outcomes, without representing the totality of information available to the election betting markets.

Reference:
Richard Roll, Orange Juice and Weather, The American Economic Review, 74, 5, 1984, 861-880.
Link at: http://www.e-m-h.org/Roll1984.pdf

NBS Elite

November 16, 2011 § Leave a comment

NBS Elite is a web-based network whereby scholars and experts at Nottingham Business School, or associated in some way with NBS, can deliver a short structured contribution on an identified topic within their area or areas of special expertise. NBS Elite also hosts invited contributions from other leading international experts. The editor-in-chief of NBS Elite is Prof. Leighton Vaughan Williams, who is based at Nottingham Business School, Nottingham Trent University.

The approved format for contributions can be listed in three parts:

  1. A maximum of 500 words.
  2. A maximum of 2 diagrams, graphs, illustrations, pictures or photographs.
  3. A maximum of 5 references or links.

In this way, NBS Elite aims to provide an important and well respected source of accessible knowledge, information and perspectives.

Leighton can be contacted at: leighton.vaughan-williams@ntu.ac.uk

November 14, 2011 § 1 Comment

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