8. Targeting Fuel Sales
MED has asked that we consider the impact of requiring a mandatory percentage of total transport fuel sales to be bio-fuels, rather than a mandatory percentage of each litre of fuel to contain a biofuel component. The precise implications of this approach are unclear and would depend on firm behaviour. However our analysis suggests it may see a blend requirement becoming a de facto ethanol blend requirement, with the results in terms of net costs and benefits being the same as those outlined above for ethanol.
In deciding whether to sell biodiesel or ethanol to fulfil a mandatory blend requirement firms would most likely base their decisions on:
- Choices of other firms
- Security of supply of ethanol and biodiesel
If a firm chooses to supply biodiesel blends while another chooses to supply ethanol blends, then the firm which chooses biodiesel is likely to loose diesel customers to the firm offering ethanol blends because the diesel price will be cheaper from the ethanol supplier. Similarly, the firm which chooses to offer ethanol blends is likely to loose petrol consumers to the firm which offers diesel at the higher biodiesel blend price but petrol at the lower non-ethanol blend price.
Whether a firm chooses to supply more of one fuel or the other will most likely depend on the section of the market served by the firm. A supplier who is heavily dependent on diesel sales may choose to offer mainly ethanol blends, while a firm which serves a mainly petrol consuming market will most likely choose to offer mainly biodiesel blends.
In our view, it is also likely that fuel prices will rise across the board, with conventional fuel prices rising to cross subsidise the sale of biofuel blends. Assuming that cross-subsidisation does not occur to the point where prices are kept artificially high, cross-subsidisation would have no material effect on our cost benefit analysis above. Thus a fuel sales target would have costs and benefits somewhere between the bounds of our above analysis. If one-thirds of a 3% requirement were met with biodiesel and two-thirds were met with ethanol, the net result in terms of costs and benefits would simply be one third of the BD3 benefits (and resource costs) described above plus two-thirds of the E3 benefits described above.
Security of supply will feature quite strongly in biofuel choices by firms and may preclude sales of biodiesel over the medium term. That is, other things being equal firms would choose the fuel with the lowest supply side risk because insecurity of supply places risks on investment in infrastructure such as storage and distribution facilities.27 Given the relative security of supply of ethanol over biodiesel, at least at present, we would expect fuel suppliers to initially choose to offer ethanol blends over biodiesel blends. This would have the effect of making a biofuel sales target a defacto ethanol blend sales target. This may be problematic in so far as the net benefits of biodiesel are greater than ethanol.
However, there is merit in a sales target because it would give transport fuel providers additional flexibility for implementing biofuel requirements in a least cost manner. We would expect the end result in terms of benefits to be the same as that for mandatory fuel blend percentages, but the costs might be slightly smaller. Costs that might be minimised include losses in consumer welfare and economy-wide costs in terms of allocation of resources.
A sales target would provide transport fuel producers and merchants with flexibility to target biofuel supply at those consumers who have the most inelastic demand with respect to fuel use. Dead-weight losses would be minimised as a result. A biofuel sales target may therefore result in transport fuel suppliers offering a range of biofuel blended products, from low biofuel blends or straight conventional fuels targeted at one consumer group to fuels with high percentages of biofuels targeted at other consumer groups.
It is not possible to say with any certainty whether transport fuel suppliers would offer a range of biofuel blends and what the range of products may be. Indeed it may be the case that the costs of differentiating between one group and consumers and another may outweigh the benefits of targeting certain consumers. However, the thrust here is that transport fuel suppliers are best placed to determine if the benefits of offering a range of different blend percentages outweigh the costs. With a mandatory blend percentage, rather than sales percentage, suppliers' would not have the flexibility to explore such an option.
Similarly, resource costs in terms of infrastructure required to produce, blend, and store, and distribute biofuels might be minimised if firms have the flexibility to determine where they supply biofuels and in what percentage blends. That is, it may be feasible for firms to offer biodiesel at higher blends in built up areas, for example. Or fuel suppliers may be able to target bulk/wholesale purchasers and hence not have to put distribution or storage facilities in place at all points of sale. This could yield economies of scale and reduced overall resource costs - which would be reflected also in the pump prices of biofuel blends and thus reduce consumer losses. As above, we cannot pre-judge what the outcome would be in this regard. Transport fuel suppliers are best placed to know if their existing clientele and cost structures allow for such cost minimisation strategies. But, as above, if biofuel use was required on a percentage blend basis, this flexibility would not be available.
As mentioned above, any minimisation of costs to consumers from mandatory biofuel use would, however, be small compared with the quantum of potential costs outlined in section 5. Therefore, our best estimate of the costs and benefits of a mandatory biofuels sales target of 5% of fuel sales phased in from 2006 would result in costs and benefits not materially different from the E5 analysis above. That is: a present value total cost to consumers of $4 million between 2006 and 2012; resource allocation costs of $221 million; and benefits from CO2 reductions of $7 million. This cost would of course be lower if a significant biodiesel industry had been established in New Zealand.
The targeting of transport fuel sales requires the same supply side considerations as in the case of biodiesel blends. If a mandatory sales target were implemented in the absence of a biodiesel supply industry in New Zealand, then fuel suppliers would have no choice but to offer ethanol blends. The end result in terms of net costs would be exactly the same as for ethanol blends. That is, a requirement for 5% of transport fuel sales to consist of bio-fuels would mean a $50 million net present cost to the economy and a resource cost of $238 million in the year 2012 - in present value terms.
A biofuels target based on percentage of fuel sales would also confer an additional benefit related to implementation of a biofuel use target. It would allow firms to blend to their own specifications based on quality variations in biodiesel through the year. It would also allow firms to adjust their blends for times when supply was short - avoiding perverse results where firms are in breach of legal obligations due to seasonal variation in output or a brief biofuel supply side shock.
There may, however, be additional compliance issues associated with requiring a percentage of fuel sales to include biofuels. Under such a requirement, compliance would most likely need to be checked through audits of transport fuel firms sales and purchase records or regular reporting by transport fuel suppliers. Given the difference in fossil fuel and biofuel prices, firms would have an incentive to provide inaccurate reports of how much biofuels they had used. We would not expect widespread falsification of documents, however the fact remains that checking the validity of fuel supplier reports could be a time consuming and costly process for New Zealand regulatory authorities.
Alternatively if firms were required to use a fixed percentage of biofuels in all fuel sold, then this could be verified more accurately through spot or regular audits of fuel composition at retail and wholesale outlets. However, this too would be costly as tests for checking blend percentages are difficult and expensive to conduct.
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