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GAO report: Supply issues, incentive structures continue to challenge biofuels industry

The biofuels industry will face significant feedstock supply issues in the near future if it's to become a larger part of the U.S. energy complex, according to a study released recently by the U.S. Government Accountability Office (GAO).

The report indicates policy issues in forthcoming farm and energy legislation and the potential advancement of the cellulosic ethanol industry both play large roles in the future viability of biofuels. But, the primary limitation on ethanol as a major player as a domestic energy source is both the amount and percentage of the total available feedstock supply -- at this point, corn for ethanol and soybeans for biodiesel -- that can be devoted to the production of biofuels.

"Limits on both the total production of feedstocks and the amounts of those feedstocks that are available for energy production are also impediments to significantly increasing biofuel production," according to the GAO report. "Assuming that ethanol production continues to expand as projected by the [Energy Information Administration (EIA)], by 2012, about 30% of the corn crop will be needed to produce 11.2 billion gallons of ethanol, which would constitute 7.4% of projected total gasoline consumption."

In 2006, the GAO report indicates an estimated 15% of the corn during the 2005-2006 marketing year was devoted to ethanol to the tune of 4.9 billion gallons, an amount that comprised 3.4% of the nation's total vehicle fuel complex.

Beyond the basic bushel amount that will be required to meet a growing demand for ethanol, for example, yields must improve at a quicker clip than in recent years. The other alternative, according to GAO, is that more acres currently devoted to other purposes will have to go into corn.

"Since corn crop yields have historically only increased at a rate of about two percent per year, the corn needed to significantly increase ethanol production will come from planting more acres of corn by putting pastureland and idle land into production, planting corn where other crops were previously grown, or using corn that is currently exported or used as feed for livestock or other purposes," the GAO report reads. "Concerns exist about the potential impacts of such actions on food prices and the environment."

With the eventual development of viable cellulosic ethanol production -- which officials now guess carries a price tag twice that of today's corn-based ethanol -- government support is a likely addition to the equation to help shoulder some of producers' cost burden. "One policy option for increasing biofuel production is raising the amount or extending the duration of tax incentives for ethanol and biodiesel production. This option provides the advantage to producers of offsetting a greater portion of their costs," according to GAO.

Such a plan is not without drawbacks of its own, however. "A disadvantage is the potential for significant additional federal revenue losses, depending on the level of increase or the length of the extension," the GAO report says. "According to some economists, it is difficult to predict the effect of revised tax incentives. If the incentives are set too low to offset production costs, biofuel production will not rise significantly; if incentives are set too high, producers will receive windfall profits if production costs decline or oil prices increase significantly."

One solution here, GAO officials point out, could be a biofuels tax incentive program tied to petroleum prices in order to limit the federal government's potential revenue losses. This, like other options, is not without challenges.

"One proposal for a variable tax credit would provide five cents in ethanol tax credits for every one dollar the price of oil is below the trigger price of $45 per barrel," according to GAO. "However...establishing a variable tax credit would be challenging due to the difficulty of determining the correct trigger price for oil as well as constructing the variable subsidy to deal with constantly fluctuating corn prices."

Another challenge lies on the other side of the energy spectrum, the consumer. If adequate incentives are put in place to boost biofuels production to the point where fuel costs decline substantially, consumer behavior may negate the benefits more ethanol and biodiesel could provide.

"Assuming lower costs are passed on to consumers, they may be encouraged to drive more miles or purchase less efficient vehicles, resulting in little or no reduction in petroleum fuel consumption," according to GAO.

The biofuels industry will face significant feedstock supply issues in the near future if it's to become a larger part of the U.S. energy complex, according to a study released recently by the U.S. Government Accountability Office (GAO).

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