Forestry, biofuels and the oil crisis

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The United States has been gripped in the throes of an oil "crisis." Oil prices move steadily upwards, seemingly defying the laws of supply and demand. The laws of supply and demand have not been revoked, but they have been badly distorted. Investigation reveals that while demand has been expanding, reflecting global economic growth, supply has been stagnate, with production essentially flat since 2005. In this situation prices should rise.

Although some countries have been increasing oil production, other countries are showing declines. Mexico's oil production, for example, is declining-reflecting old depleted oil fields and deteriorating equipment. Indonesia's situation is similar. Both countries have government-owned monopoly petroleum industries that are notoriously corrupt and inept. And both countries allocate larger portions of their production to domestic use at subsidized prices. Thus, their oil exports to the rest of the world are falling. Additionally, a number of countries, including Nigeria and Venezuela, are periodically beset with political disturbances that limit both production and investment, thereby reducing output. Finally, the OPEC countries, particularly Saudi Arabia, which once used their excess production capacity to cool off a hot market, have found that their spare capacity is largely gone.

In the United States, the lower 48 states have experienced production stagnation, while the existing North Slope production in Alaska appears to have peaked. Beyond current oil fields, the U.S. Congress has been reluctant to open new promising areas for production. In Alaska, the ANWAR controversy continues but with no new production on the horizon. In the over-thrust region of the Rockies, only modest production expansions are allowed. Offshore, in a variety of attractive areas from Virginia to Florida to California, no new drilling is allowed.

By contrast, Canada is taking advantage of this situation by dramatically increasing its production from its Albertan oil sands. In Brazil, huge new offshore petroleum field finds give great promise for future production and Brazil's economy has already become energized by the prospects. World scale production, however, will not be available for at least a decade.

Exacerbating the supply side problem are the tendencies of many countries to sell oil and gasoline at fixed subsidized prices, thereby undercutting the moderating effects of price increases on consumption. China, for example, has a fixed price for gasoline that does not rise when the world market price of oil increases. The cost differences are provided by government funding; the consequence being that the demand-limiting function of price is stifled.

Not surprisingly, markets are not working very well. On one hand, political forces often intervene in the market to limit the development of increased supplies. On the other hand, political forces limit the ability of price to reflect the underlying resource scarcity; we have an artificially constrained supply trying to address a growing and subsidized demand. No wonder oil prices seem to defy market forces.

One alternative favored by Congress appears to be biofuels-specifically ethanol. In addition to being heavily promoted by use mandates, ethanol receives a 51-cent-per-gallon subsidy and is protected from competitive imports by a 54-cent tariff on foreign ethanol. The resulting unintended consequences have been the strong price run-ups for grains and related foods, which has given some members of Congress pause. Recently a group of Republicans sponsored a bill to freeze the mandated ethanol use at current levels rather than allowing it to rise as required in existing energy legislation.

Is there a future for biofuels and particularly ethanol? Ethanol is produced from sugar. The easiest and cheapest approach is to convert sugar to alcohol and alcohol to ethanol. Sugar cane has a natural advantage to produce sugar cheaply and in large volumes, and can readily be converted to alcohol. Hence, Brazil is an economically viable producer of ethanol. To use grains, such as corn, requires the grain first be converted to sugar and subsequently the sugar to alcohol. The extra processing increases the costs. Furthermore, grain's use for ethanol diverts it from food production and causes food prices to rise, further undermining its economic viability.

Another resource that could be used for ethanol is wood. Although disadvantaged by the costly process of converting wood to sugar, wood is readily available and inexpensive. Thus, while the processing costs will be higher than grain, the basic wood resource is abundant and comes at a modest cost. While perhaps the price of wood products may increase, it will not set off higher prices in food products. Currently, the processing costs for wood are too high to be competitive even with corn. However, technological innovations to reduce the processing costs are promising. Reduced processing costs together with low wood input costs could lead to a reasonably priced alternative to corn ethanol and, better yet, to oil, which is currently selling for more than $100 per barrel.

Another use of the wood resource could be wood wastes-that which contributes to the forest wildfire problem-and use it to produce cellulosic ethanol. Current U.S. legislation, however, will not allow waste wood collected from national forests to be used in such a manner, in part to reduce the chance of commercial activities on these forests. Hence, a significant wood biofuel industry would almost surely involve drawing wood from existing private forests and additional private investments in fast growing short-rotation forests. To provide for future needs, these forests would need to be sustainable. Finally, since any new forests would be on low-cost lands, marginal for crop agricultural, the impacts of food prices would be minimal.

Can biofuels adequately address the problems of the oil market? Probably not. Biofuels are a partial solution and probably only a temporary fix. The potential of grain biofuels is inherently modest in the global oil market, and so, at best, would have a minimal impact. Cellulosic biofuels, however, have substantially more potential for large volumes by virtue of the greater availability and the lower costs of wood. Using existing private and new forests, the United States could provide the raw cellulose needed for a viable wood biofuel industry that could offset a modest, but significant portion of this country's liquid fuel needs.

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Roger Sedjo is a Senior Fellow at Resources for the Future, a Washington, D.C., research organization that studies natural resources. In 2000, he served as a Julian Simon Fellow with PERC.
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