Biofuels, as a means of powering automobile engines, have been hailed as nothing short of a panacea to arrest global climate change, reduce dependence on fossil fuels, ensure energy security, and turbocharge agricultural economies. Yet these fuels, which are generally made from corn, sugarcane, soy, and other crops, also generated their share of controversy.  They have been denounced by critics who claim that they will do more harm than good to the environment and that they are not economically sustainable absent government protection.

In the flood of media attention that biofuels have recently received, it is difficult to distinguish the facts from the fanfare. Our research on the growth and viability of the biofuels market, bolstered by interviews with dozens of experts in government, corporate, academic, and nonprofit organizations, revealed several counterintuitive insights about some prevalent assumptions regarding both biofuels' promise and their impact on markets and the environment.

Perception: Biofuels are not economically viable as a substitute for petroleum.
Reality: Biofuels offer a competitive alternative to petroleum.

Although break-even costs for different biofuel technologies vary significantly, in Brazil sugarcane ethanol is already commercially viable. Introduced there in the 1970s, cane ethanol was nurtured as an infant industry and backed by public subsidies for many years. Today, 85 percent of autos sold in Brazil feature flex-fuel power trains, and cane ethanol supplies a significant portion of the automotive fuel pool based on its economic merit. Thanks to the large number of flex-fuel vehicles, consumers can opt for whichever fuel is cheaper, which ultimately varies based on the relative prices of crude oil and sugar.

Globally, corn ethanol is still much more expensive than petroleum and will be until oil prices rise another 20 percent or so. Cellulosic ethanol, although still in the early stage of development, will likely break even with petroleum when the former is around US$55 per barrel without government incentives — about half the price of oil now and a little below the International Energy Agency’s 2007 forecasted oil price of $62 per barrel in 2030.

Perhaps the biggest endorsement of biofuels as an economically viable alternative to petroleum has come from the Organization of the Petroleum Exporting Countries (OPEC) itself. Abdalla El-Badri, secretary-general of OPEC, noted in June 2007 that the consortium was considering cutting its investment in new oil production in response to moves by the developed world to create and use more biofuels. “If we are unable to see a security of demand…we may revisit investment in the long term,” El-Badri said.

Perception: Biofuel crops will crowd out food crops, driving food prices up and food consumption down in the developing world.
Reality: If crop yields and agricultural productivity improve at historical rates, future food prices need not be higher than they are today.

Some in the media have blamed biofuels for the recent run-up in food prices. Although biofuels are a contributor, current volumes are too small to account for these recent regional commodity price spikes. Other factors such as droughts and inventory levels have had a significant impact.

Despite this evidence, critics maintain that over time biofuel production will almost certainly outpace that of food crops, resulting in greater malnutrition, particularly in poorer parts of the world. These arguments seem persuasive at face value, but the developing world’s food woes cannot be laid entirely at biofuels’ door. Farmers in these markets are already at a disadvantage when it comes to accessing the latest agricultural practices and information on yield improvements. In addition, government policies, lack of infrastructure, political instability, and cheaper imports from the U.S. and Europe further depress crop yields in these areas, causing global consumers to lose up to 30 percent of their potential agricultural production today.

Replacing the appetite for petroleum with a taste for biofuels would no doubt result in the consumption of substantial agricultural resources. However, there is significant additional rain-fed land in the world available for agricultural production. So food prices in a world with biofuels will be higher than in a world without biofuels, but they will not necessarily be higher than they are today.

Perception: Government mandates and subsidies provide the necessary foundation for the development of the biofuel industry.
Reality: Government intervention can trigger unintended consequences, negating the intended benefits of biofuels.

Governments around the world have offered favorable tax treatment, low-cost loans and research funds for the development of biofuels, and a biofuels infrastructure chiefly to promote energy security, reduce GHG emissions, and protect domestic agriculture. Over time, however, greater government emphasis on biofuels puts upward pressure on food commodity prices, and tariffs and quotas have shut out economically viable options in favor of local alternatives. For example, protectionist policies in the U.S. have effectively eliminated imports of Brazilian cane ethanol.

Policies can furnish the necessary impetus to develop valuable new technologies and establish new infrastructure; the Brazilian government’s promotion of cane ethanol is the perfect example. However, policymakers must walk a fine line in promoting long-term beneficial behaviors to avoid short-term detrimental consequences. They need to pave the way to an orderly transition by introducing incentives that are broad enough to encompass long-term optimal technologies and specific enough to focus on those with the most potential.

After separating truth from fiction, our conclusion is that with sound policies in place and healthy innovation, we can expect biofuels to become a viable alternative to fossil fuels in the long term. And with careful attention to the consequences and implications of various policy solutions, business and government leaders around the world can develop a sustainable approach to biofuels that makes the most of biofuel’s economic and environmental advantages.