Discounting the Future of Biofuels

It appears that global leaders’ faith in energy technologies that can reduce greenhouse gas emissions compared to oil is waning, particularly for biofuels, as reported in GreenInc. Respondents to the survey, which included 1,000 environmental experts, ranked energy conservation and efficiency technologies as having the greatest potential impact, both short- and long-term.

Some 44 percent of respondents also said they expect that the current economic crisis will hinder progress toward an effective international climate agreement. Katherine Sierra, World Bank Vice President for Sustainable Development, noted, “The development challenge is to accelerate or maintain robust economic growth in poorer countries while also dealing with the impacts of climate change. The financial situation is no justification for postponing action on climate change. Climate change is not waiting, so we cannot wait either.”

These sentiments appear to be relevant to a rather arcane debate about the application of a discount rate to greenhouse gas reductions. The debate over the discount rate may become a more prominent issue, since it is a feature of the EPA’s Advanced Notice of Proposed Rulemaking on Regulating Greenhouse Gas Emissions under the Clean Air Act. It also appears that the EPA would apply a discount rate to greenhouse gas emission reductions in the life cycle assessments of biofuels, under the RFS.

A discount rate is used in cost-benefit analyses as a way to measure current costs against the value of future benefits. In applying the theory to reductions in greenhouse gas emissions, the idea is that the benefits are for future generations and on a worldwide scale, while the costs of deploying reduction technologies are paid by specific individuals today. Further, there is uncertainty about which technologies will provide the greatest benefit and investing in one may come at the expense of investing in others.

Gary Becker, the noted economist and University Professor at the University of Chicago, explains it by saying,

Future generations would be better off if the present generation, instead of investing the $800 billion in greenhouse gas-reducing technologies, invested the same amount in capital that would be available to future generations.
“Common sense also dictates that one recognizes that technologies will be much improved in the future, including technologies related to improving health, income, and the environment. A positive and non-negligible discount rate is the formal way to recognize the importance of these and related considerations.”

But environmentalists have traditionally opposed the use of a discount rate for environmental benefits. Lisa Heinzerling, a law professor at Georgetown University, responded to the use of the discount rate in EPA’s ANPR on her own blog page, saying, “Discounting is a technique used to reflect the idea that events occurring in the future are not as important as events occurring now. By using a fairly low discount rate, EPA avoided the severe trivialization of the future that often attends use of discounting.”

Elsewhere, though, she took issue with the use of any discount rate for environmental benefits:

We have said that the federal government places too low a value on human life; that it devalues the future through discounting; that it fixates on the costs and dismisses the benefits of environmental protection; that it slights the worth of effects that cannot be counted.
“Cost-benefit analysis is a deeply flawed device that has never been the environmentalist’s friend. It impedes rather than aids understanding of the concrete consequences of regulations. It would behoove the next president — and all who value environmental protection — to do more than fiddle around the margins of old debates, and to question whether a decision-making framework that can stare environmental catastrophe in the face and declare it ‘efficient’ is really the best we can do.”

Even proponents of including international land use change calculations in the EPA’s life cycle assessment of biofuels may take issue with the application of a discount rate to the calculation, or at least a high rate. Mark Delucchi is a research scientist at the Institute of Transportation Studies at UC Davis and developer of the Lifecycle Emissions Model. He notes that in the context of indirect land use for biofuels, “the discount rate determines the value of the reversal of the initial change: a zero discount rate gives it a value equal to that of the initial change; a high discount rate gives it no value.” And, “If the discount rate is very large, then we don’t care at all about the future reversion of land use and reversal of the initial change in emissions; we care only about initial change in land use and emissions.” In other words, using the discount rate in this context assumes that the carbon debt attributed to biofuels due to land use change is never paid back, which would be incorrect. Delucchi argues that a positive discount rate applied to the life cycle analysis should be reduced to reach zero over time.

However the debate on discount rate plays out in policies on greenhouse gas reductions and the Renewable Fuel Standard, the theory does seem to reflect the preferences of environmental leaders – that we not use biofuels today but wait for a better technology to come along in the future. The risk for them is that everyone’s faith in the ability to produce clean energy and reduce greenhouse gas emissions will start to fall.

A Tale of Two Studies

Don Mitchell of the World Bank’s Development Prospects Group has released an official version of his analysis of biofuels’ impact on the rise in global food prices. An early version of the study was leaked to the Guardian in London on July 4.

Mitchell attributes 70 to 75 percent of the increase in food commodities prices to “biofuels and the related consequences of low grain stocks, large land use shifts, speculative activity and export bans.” In other words, Mitchell assumes that U.S. and EU support for biofuel production is the direct cause of other phenomena that have contributed to the rise in food commodity prices. Mitchell attributes the remaining 25 to 30 percent of food price increases to the rising price of oil and the weakening of the U.S. dollar.

And how did biofuels contribute to low grain stocks? According to Mitchell, it is because biofuel crops were grown “on land that could have grown wheat.” Mitchell notes that worldwide wheat acreage declined by only 1 percent and wheat stocks actually grew. Nevertheless, in his opinion, more wheat should have been grown.

Mitchell’s assumptions contrast with the conclusions of other studies, including a recent one by Purdue University economists released by the Farm Foundation. That study follows others in concluding that the rising price of oil is the largest contributor to rising food costs, in part because it is a stronger driver of demand for biofuels than government policy has been. Researchers at Texas A&M University came to this same conclusion, as has been discussed on this blog.

Despite the fact that Mitchell admittedly “does not consider how supply would respond to high commodity prices and moderate price increases over time,” he nevertheless concludes that “biofuels policies which subsidize production need to be reconsidered in light of their impact on food prices.” The Purdue study concludes with a much more cautious note: “The challenge facing policy makers is to find policy options that deal with the short-term effects created by rising food prices without creating a new set of long-term problems.”

Not a Secret After All

On Friday July 4, The Guardian newspaper of London published a story (“Secret report: biofuel caused food crisis”) about a “confidential,” unpublished World Bank report it had obtained purportedly demonstrating that biofuels are responsible for 75 percent of the global rise in food prices. “The damning unpublished assessment is based on the most detailed analysis of the crisis so far, carried out by an internationally-respected economist at global financial body,” according to The Guardian.

In the story The Guardian reporter quotes a source from Oxfam, the humanitarian aid and development organization, which released its own report condemning biofuels in June. However, she does not cite a published report by the World Bank that attributes the rise in food prices to a combination of factors, including the rising price of oil, depreciation of the U.S. dollar, declining stockpiles of grains, and production of biofuels.

This official World Bank report says, “Three quarters of the increase in global maize production (emphasis mine) in the last three years went to ethanol in the US.” Translated, this means that the United States is using increased production of corn to make biofuels, not taking corn out of traditional markets for food, feed and fiber. It is not the same as saying that biofuel production accounts for three quarters of the global rise in food prices – meaning all grains, meats, poultry, etc. According to the USDA, biofuels production has not reduced exports of food or feed. U.S. corn exports reached record levels in 2007-08, and soybean exports are up as well. The U.S. livestock industry is still the top user of corn, with more corn expected to be fed to livestock in 2008 compared to 2007.

The Guardian’s story was picked up and repeated by other news organizations, even though other reporters appeared not to have actually seen the “secret” World Bank study. As Reuters noted, “Due to Friday’s Independence Day holiday in the United States the Guardian report could not immediately be confirmed.” Yet, Reuters ran the story. The Guardian then picked up the 75 percent figure as established fact in an editorial on Monday July 7.

The Wall Street Journal revealed on Monday that the World Bank report was not a secret, it was a working draft that was intended to be incorporated in a position paper released in April. “Bob Davis of the WSJ spoke with Donald Mitchell, the author of the draft report—which wasn’t secret at all, but a working paper. And like all working papers, it doesn’t reflect the official position of the World Bank.”

The Guardian story is reminiscent of Time magazine’s one-sided report back in April on the indirect land-use effects of biofuel development. That article set the stage for the current media backlash against ethanol, though few reporters have ever questioned the facts of the story.