Biofuel and the Economics of Refineries Gal Hochman

With Geoffrey Barrow, Ella Segev, and David Zilberman

Introduction of alternatives

Concerns with climate change and energy security during the last century led to

Biofuels, as well as the introduction of other alternatives to fossil fuels

Conservation, fuel efficient, and electric cars

Policy that supports and incentivizes the adoption of the new technologies

The petroleum refining: a closed economy

crude oil is used to produce gasoline and diesel, as well as other petroleum products such as liquid-petroleum-gas and asphalt.

Putty-clay structure The petroleum refining process is a capital-

intensive process, whereby once a refinery is configured and the capital investment made short-term decisions are constrained by existing technologies. This is an industry whose response to market

fundamentals is limited in the short-run but becomes much more flexible in the long run.

Not a competitive environment

The petroleum refining industry is an oligopolistic industry

This leads to differences in Environmental side effects Dynamics of the introduction and adoption of

alternatives energy sources Pricing of various petroleum products Distributional implications

The short-run implications from the introduction of

biofuel While the price of the petroleum based fuel declined,

the price of other petroleum products increased. Amount of petroleum based fuels declined, but total

fuel consumed increased – the rebound effect. However, the rebound effect is smaller the more market

power do the refineries have (i.e., the smaller the number of the active petroleum refineries).

Amount of other petroleum products declines. Amount of crude-oil consumed declined.

The long-run implications from the introduction of biofuel

Now, The petroleum refinery can adjust the technology, as well as

change the amount of crude consumed.

If the cost of technological change is sufficiently small, we get full adjustment and, in the long-run, the introduction of biofuels impacts only the petroleum based fuel. These results depend on

The cost of technological change Demand for the petroleum-based fuel

Policy conclusions from conceptual work

The introduction of bio-products, other than biofuels, play a key role in significantly impacting use of crude oil and thus the impact of fossil consumption on the environment.

The implications to greenhouse gas accounting The rebound effect is substantially smaller than

in previous studies that assumed competitive behavior.

The fall in supply of fossil fuels affected production of other petroleum products resulting in an indirect effect, namely, the indirect co-product effect, where under plausible scenarios may be larger than the biofuel indirect land use effect.

When the conceptual model meets reality

But the US is an open economy Incentives to consume less gasoline domestically

shift resources abroad, as long as exports are profitable

Shift of supply of energy away from the US reduces production of liquid fuel abroad.

However, the main benefit to the US is an improved balance of trade.

The resurrection of ethanolFindings in the late 1990s regarding the effect of MTBE on ground water and its phasing out by 2005 in key states – e.g., California,

New York, and Connecticut, led to the resurrection of ethanol

The ethanol decade While focusing on the US and incorporating

OPEC behavior into the analysis, we evaluate the effect of the introduction of biofuels on gasoline prices – decline, the rebound effect – smaller than suggested in

models that do not take into account the petroleum refining industry,

trade flows – impacted significantly, petroleum products – mix shifts away from

gasoline, and greenhouse gases – limited

Ethanol and gasoline pricesThe introduction of ethanol resulted in reduction of 2.5 US$ per barrel – a reduction of about 3% of the price of gasoline.

Energy security

In 2005, the US consumed 3,343,131 thousand barrels annually of finished motor gasoline

In 2011, the US consumption of finished motor gasoline declined to 3,194,754 thousand of barrels annually

Amount of ethanol consumed in the US in 2011 equals 67.25% of reduction in finished motor gasoline consumption.

Ethanol displaces gasolineFrom 2002 to 2011, the US consumed 31.2 billions gallons of

ethanol

Impact on the balance-of-

tradeDuring the last decade, flow of US currency declined by almost 100 billion US$

Because the US imports energy, a more favorable balance of trade yields lower energy prices (appreciation of the exchange rate and cheaper imports)

The indirect co-product effectAround 2010 we observe a decline in the share of crude allocated to gasoline

consumption but an increase in the share allocated to diesel

We also observe a change in the petroleum output mix from 2002 to 2010, as predicted by the conceptual model

Greenhouse gases

Using EIA GHG numbers, the effect of ethanol on the environment is small resulting in a reduction of about 40 million metric tonnes of CO2.

However, if gasoline was displaced with a carbon neutral product, then the stock of CO2 in our atmosphere would have declined by 306 million metric tonnes of CO2

How unique is the biofuel

story

“The war on coal”

President Obama needs to recognize

that maintaining reliable and

affordable energy is not something

that just happens. When a switch is

flipped, rarely do we stop and

consider the tremendous amount of

hard work and ingenuity that was

required to light up a room or power

equipment. [Bob Gibbs (R-Ohio)]

“The regulations the President

wants to force on coal are not

feasible. And if it’s not feasible,

it’s not reasonable … It’s clear

now that the President has

declared a war on coal. It’s simply

unacceptable that one of the key

elements of his climate change

proposal places regulations on

coal that are completely

impossible to meet with existing

technology.” [Joe Manchin (D-

West Virginia]

Supply of coal and natural gas for electricity

in the US

1994199

5199

6199

7199

8199

9200

0200

1200

2200

3200

4200

5200

6200

7200

8200

9201

0201

1201

2201

30

5000

10000

15000

20000

25000

Electric Power: natural gasElectric Power Sector: coal

Coal net exports

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

0

5000

10000

15000

20000

25000

30000

-4000

-3000

-2000

-1000

0

1000

2000

Total coal and NG MMBtu supplyNet MMBtu export

MMBt

u

GHG in the US declined, but the US exported GHG to the rest of the world

1973197

5197

7197

9198

1198

3198

5198

7198

9199

1199

3199

5199

7199

9200

1200

3200

5200

7200

9201

10

500

1000

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2000

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3000

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4000

Annual energy-related carbon emissions

coalnatural gascoal and NG

met

ric to

ns o

f car

bon

diox

ide

In conclusion: Before the introduction of the alternative

In conclusion: After the introduction of the alternative

Concerns with climate change led to policy and search for alternatives to existing fossil

fuels.

These policies and alternatives yielded a big impact on the US balance of trade, but only a limited impact on the environment.