The Rising Costs Of Biofuels

The excerpts below from an article in the WSJ are interesting because it displays a basic misunderstanding of the alternative fuels (energy) business. If alternative fuels sources were so economical that they could be produced for less then the equivalent oil price, those fuels would already be in production. Also the production of alternative fuels (or energy) commonly requires oil in the production process (farming, refining, etc.), so as oil prices increase the price of alternative fuels is going to increase. Another issue that people have commented about, is that when someone takes a commodity in economic equilibrium (supply and demand are about equal) that is used for food and moves part of that production over to make fuel the price of that commodity is going to go up. Lastly, the purpose of alternative fuels is to replace lost production of oil due to stagnating supply and increasing demand for oil. The purpose of biofuels was not to bring down or stabilize the price of oil, there is not enough biofuel production to accomplish this task. This is what “Peak Oil” looks like. Text in bold is my emphasis. Text that is not italicized are my comments.

A few years ago, many energy economists predicted that higher oil prices would ensure the success of alternative energies such as biodiesel or wind power by making them more financially attractive. In many cases, though, the opposite has occurred: Even as crude-oil prices approach $100 a barrel, some alternatives look less attractive than in the past.

One reason: Energy demand is now so intense that supplies of just about every kind of fuel are in short supply, driving up prices of the raw materials involved in making many alternative energies. Some biofuels also rely on agricultural commodities that already are facing higher demand as foodstuffs, a situation which drives up prices further.

The problem is most acute for crop-based alternative fuels, like ethanol and biodiesel, though it has also proved true to some degree for solar power, nuclear power and other competing energy sources.

Biodiesel, a fuel made from farm crops like soybean oil and palm oil, was in some cases supposed to be economically competitive with crude-oil prices as low as $50 a barrel, according to analysts who studied the industry.

But a sharp rise in the price of biodiesel raw materials -- including a more than 90% jump in palm-oil prices over the past three years -- has dramatically altered the economics of the industry. M.R. Chandran, former head of the Malaysian Palm Oil Association, says crude oil would now have to be as much as $130 a barrel before palm-oil-based biodiesel is competitive.

Other alternatives to oil, including relatively dirty ones such as coal, have also become more expensive. Coal prices have more than doubled over the past four years, and prices for uranium, a crucial ingredient in nuclear power, have increased more than sevenfold in that time frame. The cost of solar-power cells has been pushed up in the past few years by a tight supply of silicon, the main raw material in such cells.

"The cost goal posts have certainly shifted," and that is making it harder for alternatives to oil to gain traction, says Peter Tertzakian, chief energy economist with ARC Financial Corp., a Calgary, Alberta, private-equity investor. As a result, "the rate of adoption that people expected is going to be a lot slower than people think."

Of course, many types of alternative energy have made considerable progress over the past three years, and crude-oil prices would almost certainly be higher now if such fuels weren't in the mix. Sorry, I cannot buy this. There is not enough biofuel production to materially effect the supply of energy, which would alter the price of oil. Asia and other parts of the world have rolled out billions of dollars for new nuclear-power plants and liquefied-natural-gas facilities over the past several years, and spending on solar and wind power also has soared.

Global ethanol production rose 25% from 2004 to 13.5 billion gallons last year, and biodiesel capacity more than doubled to 6.1 million metric tons in that period, though the two combined still only make up about 1% of the world's transportation-fuel supply.

When biofuels only comprise 1% of the transportation fuel supply, let's face it biofuels just are not going to have much effect.

Perhaps most important, huge sums of venture-capital cash have flooded into the alternative-energy sector since 2004, raising the odds that technological advances will bring down costs in the years ahead. Who said that? Biofuels are a replacement for the stagnating oil supply.

Still, the latest surge in alternative-energy costs -- along with growing concerns about their environmental sustainability -- are forcing governments to rethink their commitment to such fuels. Some have begun to question whether they will play as big a role in the future as first hoped. Biofuels were always considered a temporary solution until a "better and more permanent" form of transportation energy could be developed.

In Malaysia, an important center for palm-oil biodiesel production, the government has held back on plans to require biodiesel blends at petrol stations because of a fear it could drive palm-oil prices too high, imperiling the country's nascent biodiesel industry.

Malaysia issued roughly 90 permits for biodiesel refineries in the past three years, but only about five are in operation. It appears that most of the others will remain on hold until palm-oil prices come back down.

In Europe, officials are still committed to a plan to meet 10% of the region's transportation needs with biofuels by 2020. But Germany has cut back on some tax incentives for biofuels, and some EU officials have questioned whether subsidies for biofuel crops are necessary in the future. Spanish energy company Abengoa SA recently suspended production at one of its biofuel facilities in Spain because of high grain prices. Similar projects have stalled elsewhere, including Hungary.

The U.S. has its own alternative-fuel woes. The price of corn, a key raw ingredient, has increased even as the market price for ethanol has been held down by oversupply. That has squeezed the profitability of ethanol producers and forced new players to cancel or delay construction of more facilities.

Some economists now fear that the current problems may remain as long as oil stays expensive and won't be easily fixed in the short term. They note that some nonoil fuels face the same supply constraints as crude oil. There may not be enough land or water to produce all the crops needed to keep biofuel prices low. Coal, while still plentiful, faces deteriorating grades and rising costs in older mines. Uranium supply is limited by the long lead times required in developing new mines, among other factors.

Another concern is that as more nonoil commodities evolve into oil alternatives, they will start to be priced the same way as crude, keeping their costs in line with international oil prices. The commodity is not oil the commodity is energy. Therefore, if someone produces a replacement for oil it will be priced at its equivalent basis in energy (for example, BTUs).

Before the latest energy boom, for instance, palm oil was viewed primarily as a source of cooking oil, and its value didn't rise and fall with crude oil. Now, it is increasingly seen as an energy source. Over the past three years, palm oil's price has risen by roughly the same amount as crude oil.