Stacking low carbon policies on the renewable fuels standard: Economic and greenhouse gas implications

Abstract

This paper examines the economic and GHG implications of stacking a low carbon fuel standard (LCFS) with and without a carbon price policy on the Renewable Fuel Standard (RFS). We compare the performance of various policy combinations for food and fuel prices, fuel mix and fuel consumption. We also analyze the economic costs and benefits of alternative policy combinations and their distributional effects for consumers and producers in the transportation and agricultural sector in the US. Using a dynamic, multi-market, partial equilibrium model of the transportation and agricultural sectors, we find that combining the RFS with an LCFS policy leads to a reduction in first generation biofuels and an increase in second generation biofuels compared to the RFS alone. This policy combination also achieves greater reduction in GHG emissions even after considering offsetting market mediated effects. Imposition of a carbon price with the RFS and LCFS policy primarily induces fuel conservation and achieves larger GHG emissions reduction compared to the other policy scenarios. All these policy combinations lead to higher net economic benefits for the transportation and agricultural sectors relative to the no policy baseline because they improve the terms of trade for US.

Introduction

Biofuel production is being promoted to achieve multiple objectives including enhanced energy security, reduced dependence on oil and mitigation of greenhouse gas (GHG) emissions from the transportation sector. At the same time, concerns about the competition for land posed by food crop based biofuels and its implications for food prices are leading to emphasis on the next generation of biofuels from cellulosic biomass. While conventional biofuels have been produced in the US using one dominant feedstock (corn), advanced biofuels and particularly cellulosic biofuels can potentially be produced using a variety of feedstocks, including crop and forest residues and energy crops. These biofuels typically have lower life-cycle GHG intensity compared to corn ethanol and would divert less land from food production per unit fuel produced since they could be produced either from crop by-products or from energy crops that can potentially be grown productively on low quality land that is marginal for food crop production.

A key policy mechanism to induce the production of biofuels is the Renewable Fuels Standard (RFS) which sets volumetric targets for different categories of biofuels, based on the type of feedstock used and their GHG intensity relative to fossil fuels.² The targets for different categories are nested within the overall target, such that the target for cellulosic biofuels is set as a lower bound while the target for conventional biofuels (principally corn ethanol) is set as an upper bound. While this allows for the possibility that cellulosic biofuels could displace conventional biofuels it would occur only if their costs of production decreased sufficiently to allow them to be competitive with conventional biofuels. Moreover, the thresholds for GHG intensity establish minimum requirements for biofuels and do not create incentives to consume even lower carbon biofuels if they are more expensive. The RFS also grandfathers certain corn ethanol production plants from the GHG requirements, thus providing no incentive for reducing the carbon intensity from fuel produced by these plants (CARB, 2009).

This has led to interest in supplementing the RFS with other low carbon policies such as a Low Carbon Fuel Standard (LCFS) that would shift the mix of biofuels towards those with lower carbon intensity. A national LCFS does not currently exist, but a state-wide LCFS has been established in California that calls for a 10% reduction in the carbon intensity (CI) of transport fuels sold in the state by 2020 (CARB, 2009). British Colombia in Canada has a similar LCFS policy. Various Northeast, Mid-Atlantic and Midwest states and the states of Washington and Oregon have been investigating the design of an LCFS for their regions. Policies similar to the LCFS are being implemented under the European Union's (EU) Fuel Quality Directive. While the LCFS would lower the GHG intensity of transportation fuel, its effect on fuel consumption and total GHG emissions is ambiguous (Holland et al., 2009). In contrast, a carbon price policy would add to the cost of consuming both biofuels and fossil fuels based on their carbon intensity and could contribute not only to GHG mitigation but also to lowering overall fuel consumption. However, previous studies show that a very high carbon price would be needed to incentivize cellulosic biofuel production (Chen et al., 2012a). A mix of policies may therefore be needed to achieve the multiple goals of reducing GHG emissions and dependence on fossil fuels while increasing energy security.

The purpose of this paper is to examine the economic and GHG implications of stacking a low carbon fuel standard (LCFS) with and without a carbon price policy on the RFS. We compare the performance of various policy combinations for food and fuel prices, vehicle kilometers traveled (VKT), fuel mix and fuel consumption. We also analyze the economic costs and benefits of alternative policy combinations and their distributional effects for consumers and producers in the transportation and agricultural sector in the US.

These combined policies are likely to differ from the RFS alone in the mix of biofuels that is consumed while continuing to at least meet the RFS. To the extent that a change in the policy mix changes the mix of biofuels consumed it will have implications for land required for biofuels and for food crop prices. Furthermore, these policies will differ implicitly or explicitly in their impact on the relative prices of alternative fuels and, therefore, in the extent to which fossil fuels are displaced by biofuels.

In examining the effect of these policies on GHG emissions, we consider both domestic emissions and GHG emissions in the rest of the world (ROW) due to market-mediated effects. Specifically, an increase in food prices could lead to indirect land use changes (ILUCs) that would release the carbon stored in natural vegetation and forests as new land is brought into crop production (Searchinger et al., 2008). Biofuel production will also displace demand for fossil fuels and lower the price of fossil fuels in the world market and cause demand to rebound back to some extent. The price induced increase in fossil fuel consumption (and VKT) is referred to as the “rebound effect” which will offset a part of the initial reduction in demand (Chen and Khanna, 2012). The magnitude of this rebound effect will influence the extent to which the RFS and the LCFS will contribute to achieving the goal of energy security and GHG emission mitigation. We do not estimate the ILUC-effect of biofuel production in the ROW; instead we use the ILUC effect estimated by other studies to examine the order of magnitude of the direct and indirect effects of the policies considered on global GHG emissions.

We undertake this analysis by using an integrated model of the fuel and agricultural sectors, Biofuel and Environmental Policy Analysis Model (BEPAM), which incorporates the interconnections between transportation sector policies and land use due to their influence on the demand for biofuels. The model endogenously determines the effects of alternative policy combinations for the mix of fuels produced, for the cost of fuel and agricultural commodities and for VKT in 2035. It considers biofuels that can be produced from several feedstocks and can be blended with gasoline or diesel as well as sugarcane ethanol that can be imported from Brazil.

The economic and environmental implications of the RFS have been studied extensively (Beach and McCarl, 2010, Chen et al., 2012a, Hertel et al., 2010, Searchinger et al., 2008). Beach and McCarl (2010) use the Forest and Agricultural Sector Optimization Model (FASOM) while Chen et al. (2012a) employ an earlier version of the BEPAM model to analyze the implications of the RFS for land use, crop price and GHG emissions. Hertel et al. (2010) and Searchinger et al. (2008) apply the Global Trade Analysis Project (GTAP) and Food and Agricultural Policy Research Institute (FAPRI) models, respectively, to investigate the direct and indirect land use changes induced by the mandate for corn ethanol. There are only a few studies analyzing the performance of a LCFS and comparing it to other policies. Holland et al. (2009) show that in a closed economy the LCFS always imposes an economic cost and that a carbon tax would be the least cost approach to reducing GHG emissions. However, their analysis does not consider an open economy with trade in food and fuel or the impacts of the LCFS on agricultural consumers and producers. In an open economy, these policies will affect the terms of trade for the US to varying extents; they will lower the world price of (fuel) imports while raising the world price of crops exported by the US. This improvement in terms of trade could offset some or all of the efficiency cost of a fuel standard; thus the net economic costs/benefits of these policies need to be empirically examined. Using the GTAP model, CARB (2009) provides an assessment of the economic and GHG effects of a 10% LCFS in California.

The rest of the paper is organized as follows. Section 2 describes the policies analyzed. In Section 3 we describe the numerical model, BEPAM. The data and assumptions are described in Section 4 and the simulation results under various policy scenarios are discussed in Section 5. Sensitivity analysis and conclusions are provided in 6 Sensitivity analysis, 7 Conclusions, respectively.