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• Costs and Benefits

In this section we present our estimates of the costs and benefits of introducing biofuel blend requirements under a variety of scenarios. The estimates are based on a series of scenarios varying by the type of biofuel in the blend, the percentage of biofuel in the blend, and the timing of the imposition of biofuel targets.

Our analysis compares changes in fuel consumption, price, and CO₂ emissions with those of our forecasts ("Business as usual" (BAU)) for consumption, prices, and emissions in each year out to 2012. Taking price and consumption changes compared with BAU we calculate the deadweight loss to consumers for each year out to 2012. The costs for each year are then discounted through time (using a 10% annual compounding discount rate) and summed to give the present value costs of each blend scenario.

To calculate the benefits of reduced CO₂ emissions compared with business as usual we calculate the implied level of CO₂ at the new consumption level (taking into account reduced emissions levels given the percentage of biofuels used) and deduct this from the BAUCO₂ emissions in each year. As per the deadweight loss to consumers, the benefit from reductions in CO₂ in each year is discounted through time and then summed to give the overall present value of the benefits of introducing mandatory biofuels. The costs of each scenario are then deducted from the benefits to yield the overall net present valued benefit (positive or negative) of each scenario.

We also provide estimates of the resource costs of each scenario. The present values of resource costs for each scenario are presented in present value terms discounted by the same (10%) rate as for the net present value calculation above.

5.1 Biodiesel Blends

For the case of biodiesel blends, we have assessed the effects of 3% (BD3), 5% (BD5), and 10% (BD10) mandatory blends with diesel introduced in 2006. We have also assessed the impact of phasing in blends of 1% between 2006-2008, rising to 3% between 2009-2011, and reaching 5% in 2012. We have not assessed the impact of blends including efficiency losses as the relative fuel efficiency of bio-diesel relative to diesel means the resulting variation is negligible. We have also examined the impact of phasing from 2008 at 1% per annum to 2009, rising to 3% in 2010, and then to 5% in 2012.

Table 3 shows that the net present value benefits from biodiesel blends are all positive and are increasing in the percentage of biodiesel that is blended with diesel. We also see that a 3% blend is sufficient to achieve the government's target of 2 PJ of transport energy being derived from renewable sources by 2012. That is, blends of 5% or 10% would be unnecessary to meet government renewable fuel use targets for the transport sector, though welfare by this measure would increase if such blending requirements were able to be introduced. But, this does not take into account the resource costs of biodiesel blend requirements.

Source: NZIER

5.1.1 Resource Costs

Table 4 provides a summary of the present value of biodiesel blend resource costs by year and as a percentage of GDP. These resource costs are in all instances larger than the present value benefits of biodiesel blends estimated above and are typically double.

These resource costs represent an efficiency loss to the New Zealand economy and a transfer of productive resources and income from the rest of the economy to transport fuel providers and biodiesel producers in particular. It is difficult to be precise about the actual cost to New Zealand in income terms from this resource cost. However, we can say that it will reduce productivity gains associated with transport use.

Over the last twenty years, efficiency gains in the transport sector have led to overall increases in productive efficiency in the New Zealand economy and changes to resource allocation. Dairy processing, for instance, is now more centralised than it was twenty years ago as a result of transport becoming more efficient and dairy processors being able to take advantage of economies of scale from central processing as the cost of transport has fallen. This sort of productivity gain will be eroded by the introduction of biodiesel blend requirements. However, whether the marginal change in fuel prices will be sufficient to significantly alter investment decisions is not clear.

Without the benefit of a general equilibrium analysis we cannot be sure what the aggregate negative impact of this resource cost will be, nor who in the economy will bear most of it. Nonetheless, the fact remains that the resource costs are non-trivial and in excess of the benefits outlined above.

Notes: (1) Present value of March year nominal GDP as forecast by NZIER

Source: NZIER

5.1.2 Supply Side Constraints

As outlined in section 2.5, supply of biodiesel is largely constrained to production of around 55 million litres per annum from around 2008. In the above scenarios most of the consumption will outstrip supply. Table 5 outlines the quantity of biodiesel required to serve demand under each scenario, by year.

Source: NZIER

This shows that unless we assume slightly more than 55 million litres of biodiesel becomes available, per annum, after 2008, then the only feasible option for a mandatory biodiesel blend is 1%.

BD1 requirements introduced in 2006 would deliver net present valued benefits of $3.3 million, excluding a present value resource cost of $46 million, and delivering 0.72 PJ of renewable fuel use in the year 2012. A BD1 requirement introduced in 2008 would yield a net present benefit of $2.2 million, excluding resource cost of $32 million, while delivering 0.72 PJ of renewable energy use in 2012.

However, it may be reasonable to assume growth in output sufficient to meet a 3% blend after 2008. But, unless there is a significant increase in capacity over and above the possible 55 million litres suggested by Argent, then a 5% mandatory blend is not feasible.

Indeed, New Zealand's present tallow production notionally allows for a total of around 104,000 litres of biodiesel annually. This precludes the use of a 10% blend. But if additional sources of production come on line, there is potential supply capable of serving a 5% minimum blend.

One would expect that the announcement of a target would lead to the introduction of biodiesel plant into the New Zealand market. Unfortunately we have not had time to canvass any likely candidates to check the validity of such an assumption. Thus for fuel security reasons a 3% blend seems most reasonable.

5.2 Ethanol Blends

Source: NZIER

For ethanol we have assessed the effects of 3% (E3), 5% (E5), and 10% (E10) mandatory blends with petrol introduced in 2006. We have also assessed the impact of phasing in blends of 1% between 2006-2008, rising to 3% between 2009-2011, and reaching 5% in 2012. Each of these scenarios is assessed under the assumption of a loss of fuel efficiency and under the assumption of no loss of fuel efficiency.

Our partial equilibrium analysis shows that ethanol blends would impart a cost to the welfare of consumers ranging from $3 million to $23 million in present value terms depending on which blend scenario is used. While the benefits are larger than the costs - ranging from $6.9 million to $32.3 million - they are smaller than is the case for biodiesel/diesel blend requirements and the costs are larger. This makes ethanol a more costly biofuel option compared with biodiesel in terms of meeting the government's renewable transport fuels target.

Differences between the net benefits of ethanol/petrol blends and the net benefits of biodiesel/diesel blends are due to variations in:

• Price
• Emissions reductions
• Tax structure underpinning the prices of petrol and diesel.

Ethanol/petrol blends are cheaper on average than biodiesel/diesel blends over our forecast horizon (see Table 7). Other things being equal this would lead to smaller costs for the lower priced biofuel blend. However, deadweight losses are larger in the case of ethanol blends compared with biodiesel blends because petrol attracts significantly higher taxes than diesel. As a result, deadweight losses and resource costs are larger compared with the case of biodiesel blends.¹⁷

At the same time as the costs from ethanol requirements are larger than for biodiesel requirements - all other things being equal - the benefits of ethanol/petrol blends are smaller than biodiesel/diesel blends because emission reductions are smaller per litre of ethanol/petrol blend compared with biodiesel/diesel blends.

Notes: (1) BD3 price change as % of BAU diesel price and E3 price change as % of BAU petrol price.

Source: NZIER

5.2.1 Resource Costs

Source: NZIER

In the above, the resource costs of an ethanol blend in present value terms ranges from $130 million to $1.06 billion. This figure represents the total value of productive resources that would need to be devoted to ethanol/petrol blends over and above that which would be devoted to transport fuel production to meet the consumptive needs of petrol consumers at the pre-blend price. To put this figure into perspective, the value of the productive loss in 2006 from an E10 blend, in present value terms is, is $112 million, which is around 0.09% of our forecast of GDP in present value terms in the year to March 2006. This number may appear small, however is a significant distortion to the allocation of resources in the economy and represents a windfall to producers and merchants of ethanol blends.

Thus, although the net present value of the decision to institute a mandatory ethanol blend does not appear huge relative to GDP and to the present bill for petrol consumption in New Zealand, the productive distortions to the New Zealand economy suggest that a mandatory ethanol blend is highly problematic.

5.2.2 Supply Side Constraints

Source: NZIER

As mentioned earlier in section 3.5, the majority of ethanol required to meet a mandatory ethanol/petrol blend will need to come from imported ethanol. Table 9 outlines the level of imported ethanol required by percentage of blend. Notably the volumes of ethanol required are large with only about 15% of requirements under an E3 requirement likely to be able to be met from domestic production. Given the cost of ethanol over and above the value of crude oil and refined petrol, the introduction of a mandatory ethanol blend would result in a non-trivial expansion in New Zealand's balance of payments deficit. For example, assuming a loss of fuel efficiency, an E3 blend would mean an increase in expenditure on transport fuel imports of NZ$500 million in 2006, over and above what it would otherwise be in the absence of a blend.