Liebreich: Biofuels – Bit-Part Player not Main Villain in Food Price Heist

By Michael Liebreich
Chairman and CEO
New Energy Finance

It is no fun being in the dock. With critics accusing biofuels of being everything from a “crime against humanity” to “unsustainable” and a “disaster”, executives in that sector must be worrying what names their children are being called at school.

The painful spike in prices of basic foodstuffs, from wheat and corn, to vegetable oils, rice and meat has prompted some in the media and politics, normally uninterested in renewable energy, to call for the abandonment of government policies encouraging use of biofuels.

The charge that the growth of biofuels output has taken land away from food production, and therefore caused the hunger, food riots and distress of recent weeks, is a serious one, but does evidence support it?

A team at New Energy Finance has spent this month crunching all the numbers on biofuel production, land use, food consumption, yields and harvests, prices and stocks. A full version of our conclusions can be found in the Research Note Drivers Of Food Price Increases: Is It Fair To Blame Biofuels? to be published soon. I hope the team will not mind me lifting the lid a fraction on their verdict.

There is no “Exhibit A” to prove the innocence, or guilt, of biofuels simply and easily. Instead, the causation for the 168% rise in grain prices and the 136% rise in food oil prices (in dollars per tonne) from 2004 to April 2008 is complex. The most revealing way of looking at the issue is under two headings – input cost changes; and shifts in the supply-demand balance.

Our analysis suggests that of the 168 percentage point rise in prices of grains between 2004 and April 2008, some 60.5 points of that reflect input cost effects. The largest slice of this 60.5% has been the increased price of crude oil, which affects the costs of farming by driving up tractor and transport costs and the price of fertilisers. A second component has been dollar depreciation, as the weaker US currency has meant higher non-dollar costs for farmers, and a third has been “other inputs” such as land and labour costs.

The remaining 107.5 percentage points of the price rise in grains come down to changes in supply and demand. Part of this is speculative. There has been a sharp increase in short-term trading volumes in grains. Hedge funds, proprietary trading desks, day-traders and others have been looking to make a turn by being “long” in a futures contract without ever taking delivery of the physical commodity. Estimating the impact on price of the speculators is impossible however, and it changes from day-to-day as the balance alters between “longs” and “shorts”.

What we can do is break down the fundamental drivers. Our analysis has measured their effects in terms of the pressure on the supply and demand for land, measured in hectares. We assessed everything from rising population and consumption per head, to agricultural yields, land use, and demand from the biofuels industry and the animal feed sector. Our calculations show that the combined supply and demand pressures were equivalent to a 4% drop in grain-growing hectares worldwide.

Within this, the dominant fundamental supply and demand factor for grains – by a long distance – has not been biofuels, but the 3.5% growth in world population since 2004. Biofuels have been the second most important supply and demand factor in grains, but only just – the fall in grain yields in Australia, caused by drought, has been almost as important. We estimate that biofuels has been responsible for lifting grain prices by at the most 8% – and that figure would only apply if the speculative effect was nil.

It is important to stress here that the influence of biofuels on the prices of some grains has been greater than on the prices of others. For instance the price of maize, the staple ingredient of US ethanol, has been more heavily affected than that of wheat. The price of rice has been little influenced by biofuels, since it is not used for fuel production.

What about food oils, the main feedstock for biodiesel? This group, including rapeseed, soy and palm, increased in price by 136% between 2004 and April 2008. Our analysis shows that some 45.6 percentage points of that 136% price increase has been the result of input costs – crude oil costs, the weak dollar, land and labour. That leaves 91.4 percentage points of the price rise to explain in terms of supply and demand changes.

Again, speculation has been a factor. For instance there has been a 123% increase in the volume of speculative trades in oilseed futures contracts since January 2004. But, as with grains, the influence of speculation on overall demand is not calculable.

Looking at fundamental influences, pressure on supply and demand for land was equivalent to reducing hectares devoted to food oil crops by 3.3%. There were some strong positive developments, such as a switch to higher yielding varieties, a rise in yields from the same varieties, and some additional planting area, but these were more than offset by four negative factors.

The biggest of these this time was the increase in biofuel production and industrial use from food oils, closely followed by changes in consumption habits – particularly in Asia, as people chose to eat more oilseeds per head – and population growth. The fourth factor, less than half as important as the other three, was urbanisation, land being swallowed up by buildings. Overall, we estimate that biofuels and industrial use absorbed 4% of available land and have been responsible for putting food oil prices up by 17%, at most.

So, do we say “guilty” or “not guilty”? My judicial summing up would indeed mention the expansion of the biofuel sector, but as only one of many culprits. Our work has shown that input costs have been very important as well as supply and demand changes.

In grains as a whole, the rise of biofuels has been much less important than population growth in the price rises. In food oils, biofuels have been relatively more significant as a price stimulant, albeit far from a predominant one.

What should the biofuel industry do? First, it must work harder to speak with a unified voice, and to use that to communicate the fact that biofuels have been only one factor in the recent food price increases. Second, it must strive to clarify the true environmental impact of biofuels and to eliminate the use of feedstocks that have a negative impact. Third, it must accelerate the development of technologies that use waste or non-food crops for biofuel production.

Download the PDF.

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