Paradox of Subsidy: Could Biofuel subsidies be increasing CO2 emissions?

Biofuel subsidies and supports have been a substantial component of world energy and agricultural policies for many decades. In the United States alone, biofuel supports cost about $11 billion in 2008, while the European Union added another $3 billion in support. These policies do not take place in a vacuum and thus have implications for the entire global energy marketplace. If biofuels were further subsidized, the demand for other energy sources at their existing prices could diminish. If a fossil fuel provider felt like there would be more subsidies in the future for alternative energy sources, they could feel the pressure to extract more energy now before prices decreased. This potential effect, known as the weak green paradox, suggests that expected increases in biofuel subsidies would encourage quicker fossil fuel extraction. This effect becomes the strong green paradox if the higher amounts of fossil fuel extraction lead to an increase in carbon dioxide emissions.

In “US biofuels subsidies and CO2 emissions: An empirical test for a weak and a strong green paradox,” R. Quentin Grafton, Tom Kompas, Ngo Van Lon, and Hang To analyze whether a weak green paradox or a strong green paradox has existed in the US since 1981. They find definitive evidence that a weak green paradox has existed, with estimates about the efficiency of biofuels providing evidence that suggests a strong green paradox has existed as well.

Grafton et al. conduct their analysis of the weak green paradox by building a statistical model of annual oil production based on the previous year’s oil price, biofuel production, and oil production, and current year energy source prices for the years 1981-2011. Biofuel production is used as a substitute for biofuel subsidies in the model because the many subsidies and supports for biofuels are applied at all stages in the production process and because subsidies have been shown to almost perfectly correlate with biofuel production.

The authors estimate the short-run elasticity of oil production in the US with respect to biofuels to be 0.04. This implies that a one percent increase in production of US biofuels would increase oil production by 0.04 percent in the next period. In the long run, this elasticity rises to 0.09, meaning a one percent increase in biofuel production increases oil production by 0.09 percent.  This definitively shows a weak green paradox occurring during the time period analyzed. To test for a strong green paradox, the authors have to make a calculation with the amount of emissions reduced through biofuel production as compared to oil production. This is difficult because different studies have estimated this figure to be as low as 12 percent and as high as 20 to 60 percent when controlling for different factors. Their analysis suggests that, in the short run, if this figure is less than 26 percent, the subsidies led to increased carbon dioxide emissions and thus is evidence for a strong green paradox. In the long run, this figure is 57 percent. The authors use this evidence to suggest the presence of a strong green paradox occurring in this time period.

The implications of the authors’ analysis and conclusions are incredibly significant as policymakers move forward and look for ways to both increase low carbon energy production and decrease greenhouse gas emissions. Efforts to subsidize any alternative energy source may have distortionary effects in the energy market that lower fossil fuel prices and potentially increase fossil fuel extraction. If expected subsidies for clean energy or expected taxation on fossil fuels increase, fossil fuel producers have greater incentives to increase fossil fuel extraction prior to the new policies taking effect. At the very least, this study suggests that regulation of negative externalities should be swift as to not give any incentive for increased production prior to the regulation taking effect.

Article Source: R. Quentin Grafton, Tom Kompas, Ngo Van Long, and Hang To, “US biofuels subsidies and CO2 emissions: An empirical test for a weak and a strong green paradox,” Energy Policy 68 (May 2014): 550-555.

Feature Photo: cc/(Walmart)