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By Robert Rapier on May 14, 2009 with no responses

Congress Kills a Biofuel Project

If we are to seriously encourage a move to biofuels, incentives are going to be required because the economics of biofuels just can’t compete with petroleum (regardless of what Vinod Khosla thinks). Eventually depletion will cause petroleum to become very expensive, and then the economics of certain biofuels (especially those with the best energy returns) are going to start looking a lot better. But if depletion occurs quickly, we are going to wish that we had provided encouragement for all sorts of alternatives. Of course not all alternatives are created equally, and there are often unintended consequences to deal with. But overall, Congress and now two administrations in a row have shown overwhelming support for incentivizing biofuel production. There is, however, one glaring exception.

I have posed the question before of whether it ever makes sense to offer subsidies to oil companies. I would argue that it does if you want oil companies to do something that economics would otherwise argue against. As an example, let’s say in the name of energy security that Congress thought it was a good idea for oil companies to invest in solar. The oil companies wouldn’t be interested if production costs are higher than the price they expect to get for the panels. The only way Congress would convince them that they should do this is by offering an incentive to do so. Oil companies are not going to otherwise make decisions that are counter to the bottom line (unless of course they are mandated to do it, and that’s another matter altogether).

Such is the case with renewable diesel. Broadly speaking, there are two different kinds of renewable diesel. Biodiesel is normally produced by reacting methanol with animal fats or vegetable oil. (See the process description at Wikipedia). The product is actually an alkyl ester. More simply put, the product contains oxygen, and is structurally different from petroleum diesel. The structural differences can cause some problems in cold weather, and this limits the amount of biodiesel that can be blended into petroleum diesel.

The second kind of diesel is green diesel, which is chemically equivalent to petroleum diesel. This product contains no oxygen, and can be blended in any proportion with petroleum diesel. It can be made via gasification from any biomass (see the Choren process) or by hydrocracking the same fats and oils that you use to produce biodiesel. Besides the structural differences in the product, biodiesel results in a glycerin by-product whereas green diesel results in a propane by-product. (All of this is explained in more detail in my Renewable Diesel Primer).

In 2007, ConocoPhillips (Full disclosure: This is my former employer) and Tyson Foods announced a partnership in which COP would hydrocrack waste animal fats and oils provided by Tyson to make green diesel. Costs of production were around $40/bbl higher than for producing conventional diesel, but COP was able to take advantage of the $1/gal tax credit that Congress had put in place for renewable diesel to bring the costs down to parity with petroleum. Whereas corn farmers love our ethanol policy, ranchers were happy with this announcement because it afforded them an opportunity to participate in the biofuels market. Tyson Foods was also happy to have another outlet for their oils, as this would take some of the sting out of higher corn prices which had cut into their bottom line.

The fact that an oil company would benefit from “their” tax credit sent the biofuel lobby into a tizzy. They asked why an oil company should be allowed a tax credit for doing this. My answer was the same one I have earlier: To get them to do something that wouldn’t otherwise make economic sense. We can have a different debate on the wisdom of the incentive itself (i.e., unintended consequences), but if the goal is to incentivize the production of biofuels, you shouldn’t selectively decide who gets the tax credit. The 1st generation biodiesel industry wanted special treatment (a $1/gallon subsidy advantage over anyone else who might like to compete against them) and they cranked up the lobbying machine.

Democrats were particularly outraged, with Lloyd Doggett of Texas suggesting that oil companies benefiting from this tax credit was a case of legislative abuse. (Especially ironic that he is going after a Texas company, mostly to the benefit of companies operating outside of Texas). They promised to correct this by making sure only targeted companies (i.e., anyone but oil companies) could take advantage of the credit. While ConocoPhillips explained that this project would simply not be profitable without the credit, the Senate called them on it and voted to kill the tax credit. The assumption is that they either thought oil companies would subsidize a money-loser from some of their more profitable divisions, or they simply didn’t want oil companies to produce biofuel. The first assumption is naive, and the second implies that this isn’t about energy security at all, but about favoring special interests.

Yesterday, COP followed through by announcing that they were indeed going to idle the project. This is certainly a victory for less efficient 1st generation biodiesel producers, and it should also be a warning to those who think 1st generation corn ethanol is going to naturally lead to 2nd generation cellulosic ethanol. Besides the technical challenges in getting cellulosic to work commercially, cellulosic producers are going to run up against those same vested interests who wish to see the status quo maintained, and who will lobby to prevent anyone from taking away their market share.

I will repeat what someone wrote to me when Congress first announced their intentions to deny the credit: “It ain’t about the fuel… it’s about a piece of the pie.”