Cellulosic biofuel production in the United States has been growing since 2014 with establishment of a few commercial scale bio-refineries and increasing total production. According to the 2016 Renewable Fuel Standard Data of Environmental Protection Agency (EPA), total production of cellulosic biofuels in the United States reached 192 million gallons in 2016.[1] EPA’s proposed 2017 renewable fuel standards for cellulosic biofuel have been updated to 312 million gallons. One of the factors limiting production of cellulosic biofuels has been the high cost of production. The cost of the feedstock, particularly if it is from perennial energy crops, could account for a third or more of the cost of the biofuel, particularly as industrial costs of producing biofuels continue to decrease over time.
The high cost of producing perennials can arise in part from the large costs of establishing them and the costs of harvesting, baling, and storing biomass. In addition to these costs, farmers may need a high biomass price to induce them to bear the risks associated with growing an energy crop and bearing the upfront costs of establishing them. The establishment costs may have to be borne upfront if farmers are unable to obtain credit for it. Furthermore, perennial energy crops have a lifespan of 10 to 15 years and a need for a long-term commitment of land to the crop. They require one to three years for establishment during which a farmer would incur fixed cost of establishing these crops and forgo returns that could have been earned under alternative use of that land (such as growing conventional crops).
Without the access to subsidized crop insurance that is typically available for conventional crops, perennial crop production also involves risks that may differ from those of conventional annual crops. In general we found that miscanthus production has lower yield risk than corn and the yield risks of corn and miscanthus are negatively correlated; as a result farmers can diversify their crop portfolio by adding miscanthus to it and reduce their overall risks. However, in the absence of crop insurance which is available to conventional crops, the production of miscanthus can be relatively more risky for farmers.
The decision to convert land from existing uses to a perennial energy crop will therefore depend on the risk and time preferences of farmers, the riskiness of alternative crops, and correlation among those risks as well as the presence of credit constraints and crop insurance. Studies suggest that farmers tend to be more risk averse than non-farm business owners and that their discount rates can be as high as 40 percent. High degree of risk aversion and high discount rate, together with a constraint on credit, can raise the price at which farmers would be willing to supply a given amount of a perennial energy crop with high upfront establishment costs.
In a study recently published in Energy Economics we investigated the feedstock costs of meeting a 1-billion-gallon cellulosic biofuel mandate with miscanthus as a feedstock. We then examined the potential for two supplementary policy instruments, namely energy crop insurance and establishment cost subsidy, to reduce the costs of meeting this one-billion-gallon mandate. These two policy instruments are relevant because crop insurance for energy crops has been proposed to manage the production risk and establishment cost subsidy is currently part of the Biomass Crop Assistance Program that was established in the 2008 Farm Bill and re-authorized in the 2014 Farm Bill. The study focuses on the rainfed area of the United States, accounting for farmers’ behavior factors such as risk and time preferences, farmers’ credit constraint status, and the opportunity costs of switching from conventional crops to perennial energy crops.
We find that the biomass production cost of meeting a 1-billion-gallon cellulosic biofuel mandate by using miscanthus are strongly influenced by farmers’ risk and time preferences as well as their credit constraint status, due to the long and costly establishment period of miscanthus. The biomass price for supplying miscanthus could range from $38 per ton to $76 per ton simply due to differences in the degree of risk aversion, the discount rate of the farmer and whether or not he is credit constrained. A high degree of risk aversion, large discount rate, credit constraint and availability of crop insurance for conventional crops can increase the total cost of providing biomass to meet a 1-billion-gallon cellulosic biofuel mandate (by 43 percent in the study).
Despite the deterring effect of risk aversion on incentives to grow miscanthus, we found that an energy crop insurance program would not be as effective as an establishment cost-share program in lowering the biomass price at which farmers would be willing to convert land from corn and soybeans to miscanthus. On the other hand, when farmers have high discount rates and they are credit constrained, providing an establishment cost share subsidy could significantly reduce the price of biomass (by up to 50 percent) and the total feedstock cost of 1 billion gallons of biofuel even net of the additional cost on the government.
Overall, the study showed that reducing variability in the returns to income from miscanthus between the establishment phase of the crop and its harvestable phase could lower the biomass price at which farmers would be willing to grow the crop. Reducing variability in returns in any given year by providing subsidized energy crop insurance was not as effective in part due to the relatively lower yield risk of miscanthus to corn and the discounting by farmers of risks that occur in the future as compared to upfront investment costs they have to bear in the near term.
Miao, Ruiqing and Madhu Khanna. “Costs of meeting a cellulosic biofuel mandate with perennial energy crops: Implications for policy.” Energy Economics, 2017, http://doi.org/10.1016/j.eneco.2017.03.018.
[1] Data available at https://www.epa.gov/fuels-registration-reporting-and-compliance-help/2016-renewable-fuel-standard-data (accessed on April 20, 2017).