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Another Way to Think About Alternative Fuels

by Michael Levi
August 4, 2011

Some people assess the relative attractiveness of alternative transportation fuels by comparing their greenhouse gas emissions to those associated with oil. Others compare different fuels based mainly on price: cheaper fuels, in this view, are invariably the most desireable ones. A third crowd, meanwhile, focuses first on whether any particular fuel can be produced at home rather than abroad. Each of these lenses leads to different conclusions: corn ethanol, for example, scores poorly on the first measure, moderately on the second, and well on the third.

In our recent article in Foreign Affairs, Bob McNally and I emphasized another priority for energy policy: tamping down the sort of fuel price volatility that can pitch economies into recession. Indeed the importance of dealing with volatility is increasingly recognized by analysts and policymakers alike. To the best of my knowledge, though, there’s no assessment out there of the relative merits of various alternative fuels when views judged by this criterion.

I thought I’d take a stab, in this post, at sketching out what such an assessment might look like. I come to pretty pessimistic conclusions regarding the potential contribution of alternative fuels to damping volatility. Fleshing this out would be a great project for a public policy student.

Consider four different alternative transportation fuel sources: biofuels (ethanol or biodiesel), synthetic liquids (gas-to-liquids, coal-to-liquids, or biomass-to-liquids), natural gas in vehicles, and electricity.

What we’re interested in is the short-run elasticity of supply for each fuel. If availability of a given fuel can grow quickly in response to rising prices, that can blunt the price rise, all of which dampens volatility. If availability is fixed, though, we wouldn’t see any supply response to rising prices, and hence wouldn’t expect any diminution of volatility.

First generation biofuels may score pretty decently on this count. Their cost is heavily dependent on feedstock and operating expenses. A rising fuel fuel price environment, then, could spur additional production. The big variables, it seems to me, would be the availability of spare distilling capacity, and, if there isn’t much, the time required to build more plants.

Cellulosic ethanol would probably perform less impressively. Capital costs for cellulosic ethanol are expected to dominate feedstock ones. That makes it more likely that whatever facilities exist will already be running at full capacity when a price shock hits. That would leave them without any room to expand supply in response.

Synthetic liquids also hold out little promise. The economics of GTL and CTL would look pretty attractive right now if investors could bank on current commodity prices lasting forever. But both sorts of plants cost a ton of money (and GTL ones entail substantial technical risk too). Investors probably won’t build them en masse unless they’re super-confident that long-term commodity prices will make them profitable. This means that once plants are built, they’ll probably be operated at full tilt, leaving no room for rapidly expanding fuel production in response to high prices. The two exceptions would be in the case of mass miscalculation by investors, which could leave the world with lots of spare (X)TL capacity (analogous to the overinvestment in oil in the 1970s that left OPEC with a long spare capacity hangover) and strategic investment in spare capacity by states.

Electricity is a bit trickier to think through. Once I buy an electric car, it’s almost invariably cheaper to use it than to drive using gasoline or diesel. If I’m already using electricity, then, I won’t change my behavior in response to an oil price shock, and hence won’t implicitly expand the supply of electricity used in transportation. Ditto for natural gas vehicles. But I can think of a couple possible exceptions. If I’ve got a plug-in hybrid electric vehicle, and oil prices jump, I might make more of an effort to charge it frequently enough to avoid switching to the gasoline engine. And if I’ve got two cars – a gasoline powered one and an electric one – I might lean harder toward using the electric one only.

This actually suggests another angle: behavioral flexibility (which is really a demand side option) might be more powerful than having multiple fuel options. Having public transit options, for example, allows people to switch rapidly to transit as their source of mobility and away from gasoline. And since transit tends to be publically subsidized, “spare capacity” of mobility is more likely to develop.

Like I said, though, this is all pretty preliminary thinking. If anyone decides to flesh out this exercise, or if I’ve missed the publication that already does it, let me know – I’d love to see the results.

Post a Comment 3 Comments

  • Posted by Dan Alger

    I think of the call for “energy independence” as a call to reduce our economy’s vulnerability to larger-than-competitive oil price changes, either because the changes were politically driven or from a cartel.

    One way to reduce our vulnerability to supra-competitive price changes is to increase our ability to shift away from the higher prices oil when prices increase. You consider what ability we would have to do that in the short term.

    Another way to reduce the harm to our economy from such a price change is to consistently use less oil from OPEC. To the extent that we replace our use of oil with ethanol (from corn, biomass, or coal), electricity in cars, natural gas for vehicles, more fuel efficient cars and trucks, more use of rail, or less travel, our economy would have fewer people affected by an increased price of oil. This makes us more “independent” of political choices elsewhere.

    Increasing these sources through a gradually raised oil tax (along with an equivalent tax decrease elsewhere) and eliminating the hodgepodge of subsidies, tax preferences, and regulations that we have now, would be an efficient way to address this. Europe and Japan have been following this approach for decades.

    [ML: All reasonable. You clearly look at the issue through frame #3: more domestic supply (including of efficiency). One note: price spikes that result from political decisions are no more painful than ones that result from other drivers. Why discriminate so strongly?]

  • Posted by Dan Alger

    “price spikes that result from political decisions are no more painful than ones that result from other drivers. Why discriminate so strongly?”

    1. One we can’t change; the other we can have some effect. If we increase our response to a price increase, future prices won’t change as much, future support of terrorists may drop. We can weaken the incentives to stay within OPEC.

    2. We can improve incentives for related policies. We have something on the order of $100B/yr of gov’t spending to stabilize oil prices or to deal with the side-effects of such policies. One reason to discriminate is to improve political incentives and have oil users pay for these in proportion to their use.

    3. Not at all the same size. Competitive markets would have small, frequent price changes that change with the underlying economic fundamentals, taking decades for large changes in costs. Politically driven price changes are often huge relative to these, drastically reducing the value of all energy-intensive durable equipment as it’s now far from optimal.

  • Posted by Bernard Fenley

    This is where the recently enacted American Recovery and Reinvestment Act of 2009 predicated which provides among others “Program for alternative fuel, infrastructure and advanced technology vehicles”. This might receive recognition tantamount to it’s wide acceptance. Comparatively, the political and economical situation of alternative fuel is inimical, but that’s not end there. In Ohio in particular, farming of alternative fuel is being encouraged. This has the huge impact on the local economy of the state itself. Awareness coupled with acceptance will result to a consequent reduction in conventional fuel.

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