The Renewable Fuel Standard (RFS) has mandated that 16 billion gallons be produced from cellulosic feedstocks by 2022. Cellulosic feedstocks include dedicated energy crops (such as, Miscanthus and switchgrass), crop and forest residues. The mandate has been repeatedly waived, in part, due to lack of a commercially viable technology for biofuel production at reasonable cost and inadequate supply of feedstocks. The Biomass Crop Assistance Program (BCAP) was established by the Food, Conservation, and Energy Act (FCEA) in 2008 to supplement the RFS and directly support production of biomass from crop residues, woody feedstocks and energy crops for bioenergy. It has been reauthorized by the recent Agriculture Act, 2014. BCAP encourages the establishment of dedicated energy crops and the collection of existing biomass from crop and forest residues.
Energy crops are promising feedstocks for biofuels because they have relatively high yields of biomass per acre of land. They can be grown on land that has low productivity for producing conventional crops and with relatively low fertilizer application rates. They also have the potential to provide a number of environmental benefits, such as soil carbon sequestration, large savings in life-cycle greenhouse emissions relative to coal and oil, and reduction in soil erosion and nitrogen leaching. However, the perennial nature of these crops, high fixed costs of production, and lags in establishment can create disincentives for farmers to convert land from annual crops to them.
BCAP overcomes the chicken and egg problem associated with growing energy crops. These perennial crops can take one to five years to get established depending on the energy crop. Farmers are reluctant to invest in them unless they are assured of subsequent demand for these crops by a bioenergy processor. Processors have to make a commitment to farmers to plant these crops several years prior to the time they will actually buy them. As a condition for eligibility for receiving BCAP subsidies, the program requires farmers and processors to match up and arrive at an agreement to produce and buy biomass.
The program is also designed to provide government support to lower the cost that a bioenergy processor will have to bear for acquiring biomass from a farmer. This support is provided through three different types of payments.
1. Payments to cover 50 percent of the costs of establishing dedicated energy crops. Total payments per acre are capped at $500 per acre.
2. Annual payments for up to 5 years for herbaceous energy crops and up to 15 years for woody biomass to cover the foregone income from the land during the establishment period before the energy crop is harvestable and generates revenue.
3. Matching payments of $20 per ton for mitigating the cost of harvesting and transporting biomass to the processing facility.
Enrollment in the program is subject to various conditions based on the location of the farm and designated BCAP project areas, the farm conservation plans, and the establishment of a relationship between the producer of biomass and a processor that would use biomass for producing bioenergy.
How much can BCAP lower the cost for a processor of acquiring biomass from energy crops from farmers? This will depend on (a) the type of energy crop and (b) the risk and time preferences of a farmer. BCAP’s effectiveness in reducing the cost of energy crop production is higher for Miscanthus than switchgrass because the former has a higher establishment cost. It will also lower costs much more for farmers that have high discount rates and are risk averse.
Breakeven Price of Producing Energy Crops
The costs of producing energy crops include the cost of establishing, harvesting, storing, and transporting them and also the cost of land. The cost of land is the income foregone from using that land for other uses, such as, for crop production, enrollment in the Conservation Reserve Program, or providing recreational amenities. The establishment period could range from one year for switchgrass, up to three years for Miscanthus and five years for woody crops, such as poplar. Establishment costs for energy crops, such as switchgrass, Miscanthus, poplar, and willow, can range from less than $100 per acre for switchgrass to more than $1,000 per acre for Miscanthus and willow. Each of these crops requires a different time commitment; Miscanthus requires a time commitment of at least 15 years whereas switchgrass has a lifespan of about 10 years. Woody crops, such as poplar and willow, have even longer time spans of 18-25 years.
The establishment cost and the foregone income from land converted to the energy crop during the period of establishment are a fixed cost. A farmer has to compare the current value of returns in the future over the lifespan of the crop with these fixed upfront costs. The current value will depend on the rate of discount used to convert future earnings to current income. If farmers have a high discount rate, they will need much higher returns in the future in order to have the incentive to invest in an energy crop.
The graphs in Figure 1 show our estimates of the breakeven price needed in different regions of the rainfed United States to cover the cost of producing switchgrass and Miscanthus by a farmer who is risk neutral (who makes an investment decision based on expected returns and is not concerned about the variability in those returns over time) and has a relatively low discount rate of 2 percent. The breakeven price of producing these crops on marginal low-quality land is almost half of the breakeven price of producing them on high-quality cropland. The breakeven price of producing both Miscanthus and switchgrass are lower in the South and Midwest than in the Great Plains. In general, this price for producing Miscanthus is lower than that of switchgrass in every region except the Great Plains. The breakeven price of biomass is lowest in the Southeast at $40-50 per ton and would result in a biofuel production cost that would be competitive with energy equivalent oil at $100 per barrel. On average, the breakeven price of Miscanthus is $80 per ton on cropland and $40 per ton on marginal land. The corresponding price of producing switchgrass is $120 per ton and $45 per ton.
Figure 1: Breakeven Prices for Miscanthus and Switchgrass in Various Regions ($ per ton) for a Risk Neutral Farmer at a Discount Rate of 2%
The breakeven price estimated above did not consider the riskiness of returns to energy crop production that could affect a risk-averse farmer’s decision to grow them. Returns to energy crops are likely to vary over time due to weather-elated variability in yields, price variability, potential for refinery shut-down due to an economic downturn, and uncertainty about future policies that drive demand for bioenergy. These risks will depend on the type of contractual/marketing arrangement between the farmer and the processor.
A typical contract might involve the payment of a fixed price per ton of biomass for delivery of biomass to the processor. At a minimum, this would expose farmers to a risky revenue stream with revenues varying year to year depending on the yield of the crop they grow. If the contract requires the farmer to deliver a guaranteed amount of biomass, variability in yield could impose other costs, such as penalties for under/over delivery or costs of procurement of biomass from other sources.
The risks of growing energy crops will need to be compared to those of other uses of that land. In the case of marginal/idle land or land likely to be enrolled in the Conservation Reserve Program, the riskiness of existing returns is low. If a farmer is converting cropland to energy crops, then the riskiness of returns to energy crops relative to that of conventional crops will need to be compared. Additionally, to the extent that the yield risks of energy crops and conventional crops are negatively correlated, a farmer can diversify his portfolio by growing a mix of energy crops and conventional crops and reducing the overall riskiness of crop production. In the presence of risk aversion among farmers, the cost of producing these crops will have to include a risk premium to induce a farmer to give up a lower but certain income (for example on currently idle/marginal land) in exchange for a higher but risky one.
Figure 2: Riskiness of Yields of Miscanthus, Switchgrass and Corn
The maps in Figure 2 show the variability in yields relative to average yield. Darker shades indicate greater variability in yield. Corn yields are generally more variable than those of Miscanthus but less variable than those of switchgrass. Miscanthus yields are more variable in the Great Plains and the Southeast than in the Midwest and South-central regions. Even though Miscanthus yields may be less variable than those of corn, the returns from Miscanthus production are more variable than those of corn. This is because the costs of Miscanthus production are largely fixed costs (consisting of the costs of establishment and land) that are incurred irrespective of the yield of the crop. Thus returns vary much more than they would if costs were also variable and could increase or decrease as yields increased and decreased. Moreover, the presence of subsidized crop insurance for corn and soybeans further exacerbates the relative riskiness of returns to energy crops as compared to conventional crops. As a result of this riskiness of return, farmers that are risk averse will need a risk premium above the cost of production in order to be induced to grow energy crops. High-discount rates and the high degree of risk aversion could result in significantly higher breakeven prices of energy crops than shown in Figure 1.
A recent survey of farmers by us indicates that a large percentage of farmers are unwilling to give up current dollars for future dollars with certainty unless the rate of return is at least 10 percent. This is of course significantly higher than the market return on savings and could reflect a desire to see a smoother income stream to support their current life style and an aversion to waiting for returns. This implies that a much higher price of biomass will be needed to induce farmers to grow energy crops than would be expected based on the use of a low discount rate of 2 to 4 percent. The survey also showed that the majority of the farmers describe themselves as being either cautious or willing to take risks only after suitable research. Other studies suggest that farmers are typically willing to give up about 10 percent of a risky return in order to have a guaranteed income.
How much can BCAP Payments Reduce the Breakeven Price of Biomass for a Farmer?
We examine the effect of various assumptions about the discount rate and degree of risk aversion of a farmer on the breakeven price of Miscanthus and switchgrass production. For illustration, we assume an average yield of Miscanthus on cropland and marginal land of 10.7 and 13.3 tons per acre per year, respectively. The average yield of switchgrass on cropland and marginal land is assumed to be 5.2 and 5.9 tons per acre per year, respectively. The establishment costs of Miscanthus are assumed to be $1,474/acre and of switchgrass to be $104/acre. We consider the cost of producing Miscanthus and switchgrass for four types of farmers. Farmer A is assumed to be risk neutral and has a low discount rate of 2 percent. Farmer B is risk neutral but has a high discount rate of 10 percent. Farmer C is risk averse and concerned not only about expected returns but also the annual variability in those returns and has a low discount rate of 2 percent. Farmer D is risk averse and has a high discount rate of 10 percent.
As shown in Figure 3, all other things being the same, a high discount rate and high risk aversion can increase the breakeven price for Miscanthus grown on cropland from $80 per ton to $110 per ton and on marginal land from $40 per ton to $55 per ton. It will similarly also raise the breakeven price needed to induce a farmer to grow switchgrass.
We then examine the impact of a BCAP payment policy, as described above, on the breakeven price needed to induce these farmers to grow switchgrass and Miscanthus. By covering at least a part of the fixed costs of growing energy crops, the program reduces the risks to the farmer/processor and the discounted returns needed to induce production. This, together with the per-ton subsidy paid by BCAP, will reduce the biomass price that a processor will need to pay a farmer to induce production of the energy crop.
Figure 3 shows the cost of producing Miscanthus and switchgrass for these four types of farmers on high-quality cropland and on marginal land. It shows that the impact of BCAP in lowering the breakeven price that Farmer A would require to grow Miscanthus or switchgrass is fairly small, 12 percent and 8 percent, respectively. The extent to which BCAP can lower the biomass price that would need to be paid to induce a farmer to grow these crops increases as the risk aversion and discount rate increase. For Farmer D, BCAP can lower the biomass price needed by 29 percent and 15 percent for Miscanthus and switchgrass, respectively. Thus, the program benefits are higher if farmers are risk averse and have a high preference for immediate returns. BCAP can bring the breakeven price needed to induce Farmer D to grow Miscanthus to the same level as that needed for Farmer A in the absence of BCAP; it can therefore neutralize the effect of a farmer’s risk and time preferences on the breakeven price of biomass. The percentage reduction in price due to BCAP is similar on cropland and marginal land.
Figure 3: Breakeven Prices for Miscanthus and Switchgrass With and Without BCAP ($ per ton) for Various Types of Farmers
Summary
Programs such as BCAP can support the production of energy crops and lower the price needed to induce farmers to convert land to these crops. The extent to which this is the case is higher when farmers have high discount rates and a high degree of risk aversion. BCAP has the potential to lower the cost of producing cellulosic biofuels for processors and can translate into lower cost of biofuel blended transportation fuel for consumers.
However, funding levels for BCAP have diminished over time from “such sums as necessary” in 2008 to $20 million in 2013. Under the FCEA 2008, the program provided a 75 percent cost share of establishment costs, annual payments to cover the cost of land during the no-harvest years and a matching payment of up to $45 per ton for two years. Most of the initial funds, amounting to $245 million by 2010, were spent on matching payments for woody biomass collection. A much smaller amount of $35 million was spent on establishment costs and annual payments by 2012 to enroll about 42,000 acres to grow perennial grasses. Under the recent Agriculture Act 2014, the annual budget for the program is limited to $25 million a year for five years. Additionally program payments per acre have also been lowered as described above.
The prospects for funding even at this lower level have been cast into doubt by the recent House Appropriations Committee’s agricultural appropriations bill for 2015, which seeks to reduce funding for BCAP to $15 million a year. At current levels of budgetary support, the number of acres of energy crops that can be enrolled in BCAP is likely to be small and its effectiveness in increasing the competitiveness of cellulosic biofuels is likely to be limited.
This post was submitted by Madhu Khanna and Ruiqing Miao.