Monday, June 30, 2008

[PBN] UNCTAD´s position on biofuels

From: United Nations Conference on Trade & Development (undated) - June highlights

Public opinion on biofuels has shifted from the hearty enthusiasm of a few years ago to present scepticism or open condemnation. Recent articles in the press have identified the diversion of crops to the production of biofuels as being a major factor in driving up food prices around the world. Such reports rightly point to some of the pitfalls of introducing biofuels policies without duly assessing their overall implications, including on the agricultural sector. The relationship between biofuels and food security, however, is complex and needs careful assessment.

World cereal and oilseed prices have risen sharply in the last year, but for different reasons.
  • Wheat prices increased by 126 per cent in the period January-April 2008, as compared to the same period in 2007. However, only 1.4 percent of wheat is used for biofuels production in the European Union and about 0.6 percent globally. It is therefore unlikely that demand for wheat to produce biofuels has directly contributed to the recent food price increases, while it seems more likely that unfavourable weather conditions in some key producing countries, such as Australia and Ukraine, have had a more influential role on prices. However, some indirect effects, through land-use changes, may have occurred.
  • Maize prices increased by 23 percent during the period July 2007-March 2008. This relatively modest increase comes after a 45 per cent surge in 2006/07. In the United States, the use of maize for ethanol production is expected to almost double between 2005/06 and 2007/08. In 2009, it is forecast that almost 38 percent of total United States domestic maize use, equivalent to 100 million tons, will be devoted to biofuels production. The expansion of the domestic ethanol industry is linked to the provisions of the 2007 Energy Bill, which require minimum annual levels of biofuels in United States transportation fuel Therefore, there may well be links between maize utilization for biofuel production and rising maize prices.
  • The price of rice increased dramatically during last year: by early May 2008, prices were more than double their May 2007 level. The combination of export restrictions put in place by some major rice producing countries and surging import demand by other countries - which wanted to compensate for losses incurred by floods or to reconstitute rice reserves - has had a dramatic effect on the market, especially since November 2007. But rice is not used for biofuel production, and so far only small amounts of rice cropland have been shifted to producing biofuel feedstocks.
  • The price of sugar, a major biofuel feedstock, reached a 25-year high in 2006 but then fell back again later in the year and continued to decline throughout most of 2007, due to large oversupply of sugar on the market. Prices started rising again at the end of 2007, and by the end of the first trimester of 2008 had reached a level 30 per cent higher than in November 2007, before starting to decline in April. Prices have increased despite of an expected second consecutive year of surplus supplies in 2007/08. The following factors have been mentioned to explain the apparent disconnection between international sugar prices and market fundamentals: high energy prices, the weakness of the United States dollar, and the potential influence of investment funds on the sugar futures markets. Increasing demand for sugar for ethanol production has not modified the situation, in which global sugar production is estimated to exceed consumption.
  • The price of oilseeds went up 94 per cent compared with last year and 140 per cent compared to 2006. Biofuels are becoming a significant driver of the oilseeds market, both directly through the use of vegetable oils for biodiesel production, and indirectly as increased cereal demand for ethanol production affects the relative prices of oilseeds and thereby the competition for arable land between these crops. The use of vegetable oils for biodiesel production may alter trade patterns. This may be particularly the case in the European Union, the largest global biodiesel producer, where the use of rapeseed oil for biodiesel production could reach over 8 per cent of worldwide and 41 per cent of domestic vegetable oil consumption by 2017. The European Commission's proposal for a mandatory 10 percent minimum target for the share of biofuels in transport gasoline and diesel consumption by 2020 is likely increasing pressure on the oilseeds market.
Recent price spikes have occurred against the background of a long-run tendency towards increasing demand for food products, due to population and economic growth in emerging economies, and are closely linked to long-standing problems in the agricultural sector.

It is UNCTAD's view that increased biofuels production has been, for certain crops and certain countries, a driver of food price inflation, but not the dominant one. Long-term factors - such as the failure of giving the agricultural sector the importance it deserved during the last decades, lack of investments in productive capacity and infrastructure, distorted agricultural markets and the dismantling of support policies for domestic markets in developing countries - seem to be by far more accountable for the present food crisis than biofuels.

Long-term factors have combined with unfavourable weather conditions in key food-producing countries (possibly due to the effects of climate change), strong increase in energy prices, the imposition of export bans or restrictions for some staples and speculations into agricultural markets, with a magnifying effect. Furthermore, where biofuels have had an impact, the relationship between biofuels and food price spikes should be interpreted more as a policy failure than as an intrinsic and unavoidable consequence of the production of biofuels. A brief analysis of the main features of the biofuels market will clarify this view.

How does the biofuels market function?

Increasing fossil fuel prices, energy security concerns and environmental consciousness - especially related to climate change stabilization - have motivated countries to explore alternative energy sources, including biofuels. Because of the expectation that biofuels could contribute to a slowdown of the process of global warming, enhance energy security, provide opportunities to diversify agriculture production, raise rural incomes and enhance access to commercial energy, countries have put in place policy instruments that have made it possible for the biofuel sector to start and flourish. Those policies were put in place at a time of relatively low prices of agricultural commodities.

The biofuel market functions in most countries on the basis of mandated amounts or voluntary blending targets: the law requires or recommends a certain percentage of biofuels to be mixed with fossil fuels. If the required percentage goes beyond the production capacity of the agricultural sector, and if there is a preference for specific feedstocks, the market cannot function properly. The resulting pressure could exacerbate the market price reaction and contribute to generate expectations for even higher prices in futures markets.

Some examples

The United States has introduced in its 2007 Energy Bill very ambitious utilization levels of biofuels for transport - namely 9 billion gallons in 2008 rising to 36 billion gallons (136 billion litres) in 2022 - which go far beyond those included in previous legislation (7.5 billion gallons in 2011).

The European Union has set a very high target for biofuels use, which is beyond the capacity of its agricultural sector, namely 5.75 per cent mix of biofuels with fossil fuels by 2010. New legislation under discussion raises the blending rate to 10 per cent by 2020.

In addition to putting in place ambitious mandated amounts and blending targets, the United States and the European Union impose tariffs on imported biofuels and require adherence to technical requirements. Those instruments - combined with the long-standing subsidies for agricultural production, with subsidies on inputs (irrigation, fuels and credit) and, in some cases, with production-related subsidies contingent on the use of feedstock produced locally - result in a strong preference for domestically-produced feedstocks. Such policies may well put pressure on prices and induce land-use changes, with reverberating effects on global markets.

What is needed in the short term is:
  1. For the United States and the European Union and for other countries relying on mandated blending volumes or percentages to introduce flexibility in those targets so as to restore the natural balance played by markets. When biofuels are mandated, biofuel producers can outbid other consumers of the feedstocks. Moreover, rising mandated volumes fuel investor expectations about the future of the industry, further adding pressure to prices;
  2. For these countries to drop import barriers to the importation of biofuels and biofuel feedstocks. Allowing more trade in biofuels will not only reduce the price pressures on the feedstocks currently used (maize and oilseed crops), but will also reduce the costs of achieving the targets. Moreover, it will create opportunities for developing countries to produce and export biofuels to countries that need them.
What is needed in the longer term is:
  1. Support for investment efforts aimed at enhancing the agricultural productivity of developing countries, particularly of small farmers;
  2. Ensuring that these investments increase the ability of farmers to capture a larger share of the growing agricultural revenues;
  3. Promoting the development of second-generation biofuels - based on the conversion of cellulosic resources, such as grasses and fast-growing trees, into fuels - that can help to limit the direct competition between food and fuel that is associated with most first-generation biofuels;
  4. Reassess biofuel policies factoring in the actual or potential impact of biofuels production on the price and availability of agricultural commodities for food production, as well as the actual or potential impact of the price and availability of agricultural commodities on the viability of the biofuels sector.
The possible benefits

The use of biofuels in those developing countries endowed with land and other needed natural resources, favourable weather conditions and abundant labour, can be an indirect means of promoting food security and overall development, if carried out under careful strategies. For those countries, production of biofuels may help to reduce the energy bills, thereby making more funds available for other pressing needs, including food security. Biofuels can provide an alternative source of income to farmers and attract new investments and technologies into the presently neglected agricultural sector.

UNCTAD's contribution

UNCTAD has been implementing a Biofuels Initiative since 2005, and other biofuels activities under its commodities work. Through this initiative, UNCTAD assists developing countries in assessing the viability of including biofuels in their energy mix, the potential beneficial impact of biofuels on reducing imports of fossil fuels, on climate change mitigation and income earnings, and the trade-offs with food security and other domestic development priorities. UNCTAD has implemented biofuels assessment studies for several developing countries that have requested it. UNCTAD can also support multilaterally-concerted mechanisms to ensure that the benefits of expanding biofuels production are in harmony with the parallel goals of food security, environmental protection and poverty reduction.

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