No. 4 KNOWLEDGE EXCHANGE Series February 2006 Potential for Biofuels for Transport in Developing Countries by Masami Kojima and Todd Johnson 37486 This note is based on a longer report published by ESMAP in 2005. The report responds to the increasing number of requests from developing countries to help assess the commercial viability of biofuels for transport in the next 5 to 10 years. This brief draws from the successful Brazil experience and illustrates socioeconomicconsiderationsforestablishingbiofuel programs in developing countries. A Growing Biofuel Market Liquid biofuels made from biomass are attracting increasing interest worldwide. Recent surges in world oil prices, concerns about energy security, and concerns about climate change from greenhouse gas (GHG) emissions have prompted industrial and developing countries alike to pursue avenues for commercializing biofuels. Developing countries also see biofuels as a way to stimulate rural development, create jobs, and save foreign exchange. The transport sector has been the key area for large-scale efforts in biofuel use worldwide to date. The two primary biofuels consumed are ethanol and plant-oil-based biodiesel. Canada, Colombia, the European Union, India, Malaysia, the Philippines, Thailand, and the United States have all adopted Motivation behind Biofuels targets--some mandatory--for increasing the contribution of biofuels to their transport fuel supplies. Developing country interest in biofuels is motivated by several factors: Today, Brazil and the United States, which makes ethanol from maize, are the world's two largest biofuel markets. In Brazil, after Diversification of energy sources and lower exposure a period of decline in ethanol consumption, new flex-fuel to the price volatility of the international oil market. vehicles--capableofrunningonvaryingpercentagesofethanol-- Diversification is attractive for oil-importing countries, are revitalizing the sale of ethanol, which now accounts for more especially those that have high delivered costs of than 40 percent of Brazil's gasoline-ethanol market. The global petroleum (such as land-locked countries). biodiesel market--although growing--is much smaller in size. Due to higher costs of biodiesel production, ethanol offers a Rural development. Biofuels hold the promise of better chance of commercial viability, with sugarcane being the contributing to rural development by creating jobs in most cost-effective and productive source at this time. feedstock production, biofuel manufacture, and the transport and distribution of feedstock and products. Despite the growing potential, there are still major barriers preventing widespread development of biofuels. This brief Reduction in harmful pollutants from vehicle exhaust. provides a snapshot of Brazil's bioethanol experience to illustrate Where vehicles are important contributors to poor urban factors that have contributed to that country's success, and, by air quality, biofuels may be environmentally preferable to so doing, help developing countries assess the social and petroleum-based fuels. Ethanol has the greatest air-quality environmental costs and benefits of biofuels and decide when, benefits where vehicle fleets are old, as is often the case where, and how to embark on such programs. in developing countries. It helps to reduce the exhaust emissions of carbon monoxide and hydrocarbons, ESMAP is a global technical assistance program managed by the especially in cold climates. Ethanol can replace harmful World Bank Energy and Water Department (EWD) that promotes lead additives for raising the octane of gasoline, and all the role of energy in poverty reduction and economic growith in an biofuels are sulfur-free. Biodiesel reduces emissions of environmentally responsible manner. Its work applies to low- carbon monoxide, hydrocarbons, and particulate matter, income, emerging and transition economies and contributes to the but can slightly increase emissions of nitrogen oxides. achievement of internationally agreed development goals. ESMAP Knowledge Exchange Series No. 4 1 KNOWLEDGE EXCHANGE Series February 2006 Net reductions in lifecycle GHG emissions. The prospect of bilateral or multilateral aid transfers for climate Figure 1: Sugar Production Costs ($/ton) 400+ change mitigation is generating significant interest in Brazil's production cost of $0.22­0.29 per liter 400 biofuels. Developing countries do not currently have of ethanol in mid-2005 is equivalent to $35­50 per barrel of oil, depending on vehicle fuel economy. 350 binding GHG reduction targets under the Kyoto Protocol, 300 but they can sell carbon credits to countries with reduction Sugarcane accounts for 58­65% of the cost of ethanol production in Brazil. 200­250 250 commitments under the Clean Development Mechanism 185 195 200 component. 145 150 100 Risks Involved 50 0 On the other hand, developing countries are also concerned Brazil Australia Thailand 23% World Other with the potential social and economic costs of biofuel Sources: Macedo 2005, Nastari 2005. programs. These include the historical need for significant and ongoing government subsidies to the industry, the 3) Productivity in Brazil has also been boosted by decades capturing of biofuel program subsidies by large-scale farms of research and commercial cultivation. To cite one and agribusiness, fiscal and equity impacts of reducing example, cane growers in Brazil use more than 500 government revenues from tax exemptions for biofuels, commercial cane varieties that are resistant to many of implications for agriculture and agricultural trade policy, and the 40-odd crop diseases found in the country. potential environmental damages associated with feedstock production and biofuel manufacture. 4) Most distilleries in Brazil belong to sugar mill/distillery complexes, capable of changing the production ratio of The greatest barrier to widespread development of the biofuel sugar to ethanol. This capability enables plant owners to industry is economics, which is closely linked to the world take advantage of fluctuations in the relative prices of price of oil. In this context, it is useful to see how Brazil sugar and ethanol, as well as benefit from the much higher overcame this challenge and to explore the factors that price that can be fetched by converting molasses into contributed to Brazil's successful bioethanol industry. ethanol. The Brazil Experience: Ethanol 5) Flex-fuel vehicles have further increased the attractiveness of building hybrid sugar-ethanol complexes and allayed Ethanol from sugarcane grown in the center-south region of consumer fears about potential ethanol shortages. Brazil is by far the cheapest biofuel today. The financial cost of ethanol production in Brazil is estimated to be in the range A critical question for replication of Brazil's experience in other $0.23­0.29 per liter.1 developing countries is at what point on Brazil's historical cost "learning curve" will they be able to enter the ethanol The costs of ethanol production in other countries, or using market (see box 1). other feedstocks, are significantly higher than from sugarcane in Brazil. Biodiesel production costs are considerably greater-- Taking It Global at least $0.50 per liter (or $79 per barrel of biodiesel) or, in many cases, higher. Close to 100 countries around the world are growing sugarcane, but none have been able to match Brazil's In Brazil, feedstock costs account for 58 to 65 percent of the sugarcane cost structure. In mid-2005, sugar production costs cost of ethanol production, and so the commercial viability of in the three lowest cost countries were estimated to be $145/ ethanol is critically dependent on the cost of cane production. tonne in Brazil, $185/tonne in Australia, and $195/tonne in The center-south region of Brazil is virtually unmatched in its Thailand. About one-quarter of the total worldwide sugar productivity and low production costs for the following reasons: production is at $200­250/tonne, above which the cost jumps to $400/tonne and higher; these high-cost sugars in turn 1) Cane cultivation is water-intensive, but nearly all cane account for about one-half of total world sugar production fields in this region are rain-fed, in contrast to irrigated (see figure 1). Ethanol as an automotive fuel is estimated to sugar production in countries such as Australia and India. be economic in Australia in the long run only if world oil prices remain at 2005 levels (Biofuels Taskforce 2005). In 2) Sugarcane and other activities do not have to compete other countries, this breakeven point will likely be higher. for land because there is still plentiful unused land in this region of Brazil for expanding cane production. Given these cost figures, it is likely that subsidies--indirect, direct, or both--would be needed to launch and maintain a biofuels industry in most developing countries. However, the economics of biofuel production are site- and situation- 1All dollar figures cited in this brief are U.S. dollars. For conversion from the Brazilian real to the U.S. dollar, the exchange rate prevailing in mid-2005 of R$2.40 to the specific, and each country will produce different results. dollar is used. ESMAP Knowledge Exchange Series No. 4 2 Tax exemptions, administered pricing, and restrictive trade policies have all been used to assist biofuel manufacturers. Box 1: Ethanol--What Conditions Foster Success? Every country with a biofuel program has provided subsidies to the industry, and none has yet removed government fiscal 1. Do climatic conditions favor sugarcane support entirely. Brazil is the only country to have achieved a production? Is there plentiful rainfall, or a commercially competitive ethanol industry, and this was good irrigation system that is sustainable preceded by more than 20 years of government support. without large subsidies, and is soil fertility Even today, Brazil continues to maintain a significant tax adequate for cane production? differential between gasohol (80 percent gasoline/20 percent ethanol) and hydrous ethanol. 2. Is there good road and communications infrastructure? Fertile land with good rainfall must be accessible in order to minimize the costs of moving cane to processing plants and ethanol to consumption centers. One universal instrument for supporting biofuels has been tax waivers. There are both equity concerns and practical 3. Is there good agricultural research and extension, or a high difficulties for using tax exemptions to support biofuels in probability of strengthening it? The Brazilian experience underlines the developing countries. Gasoline taxes are often a significant benefits of developing new cane varieties to stay ahead of cane diseases source of tax revenue in developing countries and are also and pests, identifying the right variety for each microclimate, disseminating progressive in that gasoline consumption is greatest among knowledge through agricultural extension services, and ensuring that high-income groups. The provision of tax exemptions to farmers implement the findings and recommendations. ethanol results in a loss of tax revenue from gasoline, revenue that could have been used for other social programs. Diesel 4. Are farmers provided with adequate primary education? Especially in low-income countries, farmer education is often lacking. Farmers need fuel is either taxed at very low levels or is subsidized in many to be able to absorb and apply advice provided by extension services so developing countries. In these circumstances, tax exemptions as to be able to respond to new technical, marketing, organizational, and would not be able to support biodiesel, and alternative means financial opportunities. of support would need to be found. 5. Is there a functioning credit market? Farmers need access to credit in Government Interventions order to implement the advice of extension service officers on soil improvement; select and plant the right cane varieties; and adopt adequate Where biofuels are entirely commercially viable, government pest, weed, and disease control methods. Such measures are needed to improve cane yield to make ethanol production economic. involvement can be limited to regulating the industry to ensure a level playing field; consumer protection; and compliance 6. Is there a cadre of managers that can be called upon to manage with environmental, health, safety, and technical standards. the industry? Managerial skills, including technical management, are Under all circumstances, governments should improve the needed across the supply chain, from optimizing seed selection and harvest investment climate wherever possible by establishing a clear, timing to processing plant operations. stable, and transparent legal and fiscal framework supported by efficient administration. 7. Is the sugar industry organized to foster cooperation across the supply chain for ethanol production? Conflicts between sugar and Where biofuels are not commercially viable on their own, a ethanol producers, or between cane growers and distilleries, have slowed the growth of the ethanol industry in some countries. case for government intervention must be made: fostering rural development, accounting for poorly priced externalities, 8. Is there a mechanism for capturing poorly priced externalities? In or enhancing energy diversification. some cases, the commercial viability of ethanol will depend on charging for externalities such as urban air pollution and GHG emission reductions Rural development. Biofuel programs should be that are not financially accounted for. integrated within a broader context of investment in rural infrastructure and human capital formation. Low-income fuels are assumed to be offset by biofuels. For local air countries should assess whether the underlying pollution benefits, one set of calculations suggests that conditions for a successful biofuel program exist or could the incremental value of ethanol compared to gasoline be developed in the near term, including infrastructure may not be much higher than $0.02 per liter, and $0.08 and essential public services. for biodiesel. Biofuel feedstock production and biofuel processing may also carry environmental costs: water and Unaccounted externalities. The environmental benefits air pollution, soil depletion, and habitat loss associated of biofuels, such as lower emissions of local or global with the conversion of forests to cropland. pollutants, should be considered when assessing the economics of biofuels. Carbon market payments can Energy diversification. Biofuels can provide energy serve as an imperfect proxy for the benefits of reducing diversification, but this should be weighed against the cost GHG emissions. Using a carbon price range between of biofuels production. What is important for energy $3 and $20 per tonne of carbon dioxide equivalent, diversification via biofuels is that there be alternative, this would provide only $0.005­0.07 per liter, even if reliable, and inexpensive sources of fuels from suppliers 100 percent of the lifecycle GHG emissions of petroleum that are not traditional oil producers. As substitutes, the ESMAP Knowledge Exchange Series No. 4 3 prices of biofuels and petroleum products will equilibrate In the medium term, biofuel production costs will come down in a free trade regime on the international market and and other feedstocks may become attractive, expanding biofuels will be price takers, as long as biofuel production feedstock options and enabling countries not suited for growing remains a small fraction of total petroleum fuel production. sugarcane to enter into biofuel production. Particularly interesting is the potential for cost reduction in biodiesel manufacture from Because the feedstock currently used for commercial biofuel plants not requiring much rainfall and nutrients, such as Jatropha. production is agricultural crops, no discussion of biofuel An added benefit could be to reclaim land and provide other programs is complete without addressing global distortions in environmental benefits such as carbon storage. agricultural products, especially the domestic subsidies and trade barriers in high-income countries. The world sugar market is In the long run, one of the areas with the greatest promise to one of the most distorted. Complete trade liberalization, which become commercially viable is manufacture of ethanol from would dramatically reduce the production of sugar in high- cellulose: forest products, wood wastes, crop residues, and production-cost countries, is forecast to raise the world price of energy crops such as switch grass. Their widespread availability, sugar by about 30­40 percent according to most estimates abundance, low cost, and significant lifecycle GHG emission (ESMAP 2005). This in turn would raise the cost of ethanol reductions make them suitable and attractive for biofuel production until supply expansion responds to the much higher production. At the same time, world oil prices as well as the world sugar price. price of carbon may rise appreciably, altering the comparative economics of biofuel manufacturing greatly in their favor. Removing barriers to biofuel trade would be helpful for a number of reasons. First, the most efficient biofuel producers could References expand their market share beyond their borders. Second, the political pressure to maintain large implicit and explicit subsidies Biofuels Taskforce. 2005. Report of the Biofuels Taskforce in favor of biofuels in any given country could lessen or even to the Prime Minister. Australian Government. disappear if, in addition to or instead of domestic producers, www.dpmc.gov.au/biofuels/final_report.cfm. imported biofuels benefited from these subsidies. Both effects would provide a stimulus to increase efficiency and close ESMAP. 2005. Potential for Biofuels for Transport in inefficient manufacturers. Growth of the most efficient biofuel Developing Countries. Report 312/05. Washington, DC: manufacturers in turn would strengthen the industry and World Bank. contribute to energy source diversification worldwide. Macedo, Isaías de Carvalho, ed. 2005. Sugar Cane's Energy: In Summary Twelve Studies on Brazilian Sugar Cane Agribusiness and Its Sustainability. São Paulo: UNICA. São Paulo: In the near term, ethanol from sugarcane is likely to offer the Sugarcane Agroindustry Union. best chance of commercial viability.2 Other feedstocks for producing ethanol increase the cost of production markedly Nastari, Plinio Mário. 2005. Personal communication. and are unlikely to be financially viable without government support. Biodiesel remains expensive even against the backdrop of rising world oil prices, thus raising similar concerns over financial viability in the near term. 2Historically, world sugar prices have been as volatile as oil prices. World sugar prices reached a 25-year high in early 2006, causing the plant gate price of ethanol to far exceed that of gasoline and prompting the government of Brazil to reduce the required ethanol content in gasohol from 25 percent to 20 percent in March. Copyright 2006 Photo Credits: ©Todd Johnson and Carlos Goldgrup, Reflexo Production Team: Marjorie K. Araya, Douglas F. Barnes, and Samantha M. Constant This note is part of the forthcoming report "Potential for Biofuels for Transport in Developing Countries." Masami Kojima works as Lead Energy Specialist for the World Bank's Energy and MiningAnchor. Todd Johnson works as Senior Energy Specialist in the World Bank's Latin American Region. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author (s) and should not be attributed in any manner to the World Bank, or its affiliated organizations. To order copies of the full publication and for more information, please visit us at our website: http://www.esmap.org. The Knowledge Exchange Series is issued by ESMAP to disseminate the results of significant work in the energy sector for the benefit of the development community in the most effective and most accessible way possible. http://www.esmap.org This brochure is printed on recycled paper. ESMAP Knowledge Exchange Series No. 4 4