The role of domestic policies in biofuel market development

Domestic policies to support biofuel production respond to different policy goals associated with biofuel production. Earlier experiences such as those of the US and Brazil were mainly motivated by pressure to reduce the import bill and increase energy security, though rural support appeared as an important driver in a later stage of these experiences. Today a new policy interest is added, driven by the potential of biofuels to contribute to ameliorating the problem of global warming. All this implies that these policies cover a range of sectors, typically including energy, agriculture, industry and trade.

Given that, on the one hand, costs of biofuels production are higher than those of conventional fuels and, on the other hand, there are positive externalities associated with biofuels, the use of some form of public policy is essential to make biofuel production competitive in the earliest stages of industry development. The use of policy tools such as the setting of national targets for the blending of biofuels with standards fuels, tax benefits, subsidies and loan guarantees to encourage greater production and consumption has been the rule rather than the exception behind the development of this market. Some of the main experiences are briefly described below.

In Brazil, for instance, the 1975 PROALCOOL programme (presented in detail in Box 1) was promoted as a reaction to the oil crisis and aimed to replace gasoline with blends of bioethanol produced from sugarcane. In order to do this several policy measures were introduced including: production quotas and a fixed purchasing price for bioethanol; control of domestic bioethanol sales and distribution by a monopolistic agent (Petrobras); subsidies to bioethanol blend gasoline producers; tax incentives to car owners using bioethanol blend gasoline; and soft loans to implement the necessary technical changes for vehicles.

Although the Government liberalised this market in the early 1990s (abolition of Petrobras’s monopolistic distributional arrangement; liberalisation of bioethanol prices and reduction of subsidies on bioethanol blend gasoline producers), the Government still fixes minimum rates of blending with oil (currently at 20 to 25 per cent). In 2001 some additional measures were introduced as a means to revive the PROALCOOL programme, including a tax reduction on flexi-fuel cars (FFA), subsidies for FFA car purchasers and subsidies for sugar storage in order to secure future bioethanol supply. Even though the current level of Government support for bioethanol in Brazil is minimal compared to other countries, historically it was a key factor behind the development of the market and it still has a role to play.

Brazil would like to replicate the bioethanol programme for biodiesel, and in 2004 the Government launched the National Programme for the Production of Biodiesel (PROBIODIESEL Programme). In early 2005 the Government passed a bill, making the production of a 2 per cent biodiesel fuel blend made from castor oil and soya oil compulsory by 2007. This obligation will be increased to 5 per cent and 20 per cent by 2013 and 2020, respectively. In addition to the setting of targets for biodiesel-diesel percentage blends, the regulation also involves a framework that includes differential rates depending on the oilseeds used, where they are grown, and whether they are produced by large agribusiness concerns or family farmers. Biodiesel feedstocks and the fuel itself are exempted from Industrial Products Tax (IPI). The programme has also instituted a ‘Social Fuel’ seal which aims to promote social inclusion throughout the new fuel’s production and value chain. It establishes the conditions for industrial producers of biodiesel to obtain benefits and credits. In order to receive the seal, an industrial producer must purchase feedstock from family farmers and enter into a legally binding agreement with them to establish specific income levels and guarantee technical assistance and training.

In the US, interest in biofuels also began in response to the 1970s oil crisis, and legislation to promote the production and use of bioethanol as a transport fuel was passed.56 However, it was only in the 1980s that the US began assisting production to address the crisis in the corn industry. Bioethanol then attracted further interest as an antiknocking agent57 when lead was phased out from petrol.58 The 1990 Clean Air Act Amendments set up the oxygenated fuel programme that required petrol sold in areas with high carbon monoxide levels to contain 2.7 per cent oxygen. Later, the Reformulated Gasoline Programme required petrol containing 2 per cent oxygen to be sold in areas with high levels of photochemical smog. However, it was only with the prohibition of MTBE as oxygenate in early 1990s, that bioethanol started to be widely Used.

Several other initiatives have also stimulated uptake of bioethanol in the US. There is a US$ 0.51/gallon tax credit for bioethanol; federal agencies are required to use alternative fuels in their fleets; the Clean Cities Programme created a market for alternative-fuelled vehicles, various states offer incentives and assistance, and several have bioethanol mandates. The 2005 Energy bill incorporates the tax credit within a larger mandate, requiring gasoline refiners to nearly double their use of renewable energy additives (read bioethanol) in the coming years. In particular, it introduced a Renewable Fuel Standard that requires US fuel production to include a minimum amount of renewable fuel each year. It starts at 4 billion gallons in 2006, increasing gradually before reaching the goal of 7.5 billion gallons in 2012.59 From 2013 onwards renewable fuel production must grow by at least the same rate as gasoline production.60 In addition, US domestic producers are insulated from imports as the US adds on a US$ 0.54/gallon secondary duty to the normal tariff of 2.5 per cent to shield domestic producers from competitive imports.

Regarding biodiesel, in 2004 the US approved a tax credit of US$ 1 per gallon of vegetable oil or animal fat-based biodiesel blended with petrodiesel, which is framed in the context of the 2004 American Job Creation Act.61 Moreover, the Renewable Fuel Standard introduced in the 2005 Energy Bill also applies to biodiesel production. In the EU, biodiesel began to be promoted in the 1980s as a means to prevent the decline of rural areas while responding to increasing levels of energy demand. However, it only began to be widely developed in the second half of the 1990s. Key policies affecting the European market for biofuels include energy, agriculture and climate change policies.

In 2003, the EU approved two draft directives concerning energy supply diversification and the reduction of GHG emissions. Directive 2003/30/EC sets indicative targets for biofuel consumption in the transport sector: biofuels must constitute 2 per cent of all gasoline and diesel motor fuels by 200562 and 5.75 per cent 2010. Although these targets are not mandatory, member states must keep the EC informed about the measures taken to reach them. Directive 2003/96/EC complements this policy providing a legal framework to differentiate taxation between biofuels and conventional fuels. The minimum excise rates for unleaded premium, diesel fuel and heating oil effective from January 2004 were: € 359/m3, € 302/m3 and € 21/m3, respectively. For diesel, the minimum rate will be raised to € 330/m3 by January 2010. In addition, a number of EU countries have implemented tax credit for biofuels, including Germany, Sweden and Spain, at 100 per cent.
On the agricultural side, the 2003 EU Common Agricultural Policy (CAP) Reform introduced the ‘Carbon Credit’, which pays € 45/ha to growers of energy crops, up to 1.5 million hectares. Carbon credit is available for all agricultural crops except sugar beets and hemp, as long as they are used for approved energy uses and have a contract for this purpose.66 EU farmers cannot get carbon credit for energy crops grown on set-aside land. The amount of oilseeds that can be grown within the EU is set by the Blair House Agreement (BHA), which restricts the maximum EU oilseeds area for food use to 4.9 million/has and also limits the annual output of side products (oil meals) from oilseeds (rapeseed, sunflower seed and soyabeans) planted on set-aside land for industrial purposes to 1 million MT annually of soyabean equivalent.

In 2005 the EU released the Biomass Action Plan, which suggests a possible revision of the 2003 Biofuels Directive. It encourages, among other things, a closer look at the second generation of biofuels, and the use of bioethanol to reduce demand for diesel, and public procurement of clean vehicles – including those using high biofuel blends. In February 2006 the EU launched the Biofuels Strategy, which is a coordinated action plan to promote sustainable large-scale production and use of biofuels in the EU and developing countries. The strategy is a cross-sectoral initiative that contains seven policy axes, some of them based on measures described above but also including some new areas: stimulating demand; capturing environmental benefits; developing the production and distribution of biofuels; expanding feedstock supplies; enhancing trade opportunities; supporting developing countries; and supporting research and development.

In addition to the examples above, many other countries – in the industrialised and developing world – have either implemented or are implementing policy tools to support biofuel market development. Table 3 summarises some of these.

These policies play a crucial role in the industry’s development. However, the existence of a learning curve – as the Brazilian experience shows – suggests that the level of support can be diminished over time. On the other hand, they can also constitute very costly barriers to trade, especially for those most efficient developing countries that have less financial capacity to support their industry. The next chapter on biofuels and the rules of international trade elaborates further on this point.