Draft EU directive on the use of biofuels

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Introduction and Summary

  1. This assessment estimates the costs and benefits of a proposed EU directive on the use of biofuels which would:

(i) set targets for the introduction of biofuels in transport, from 2005 onwards across the EU; and,

(ii) require each Member State to report annually the proportion of their transport fuel sales that is biofuel.

  1. Biofuel for transport is defined in the proposed directive quite broadly as any fuel derived from biomass, although currently the main candidates are seen as biodiesel, bioethanol, and a product of bioethanol, ETBE[1].
  2. The climate change benefits that could result from meeting the proposed targets depend on the extent to which substituting biofuels for conventional fuels saves carbon on a lifecycle basis. Using the Commission's estimates of this suggests that meeting the targets could reduce 2010 UK emissions of carbon dioxide from road transport by 2.2-2.7MtC. However, the Commission's estimates are seen by some as optimistic, and DTLR's estimates suggest that a carbon dioxide saving of 0.7-1.5MtC is more realistic. There could also be an improvement in the UK's security of energy supply, through switching future fuel demand away from oil, of which the UK is projected to become a net importer in the medium term. However, this would depend on the relative risks to the supply of oil and biofuels, and where the biofuels are produced.
  3. On the basis of the Commission's own estimates of the extra production costs for biodiesel, the costs of achieving these benefits could range from around £475m to £875m per annum. However, the different options lead to the costs being borne by different groups. If a regulation or voluntary agreement were used to meet the targets by blending biofuel with conventional fuels, then the costs would be borne eventually by conventional fuel consumers. But using a biofuel duty cut would lead to taxpayers generally bearing the costs and biofuel consumers benefiting, while a voluntary agreement to increase sales of biofuels for dedicated vehicles would benefit biofuels consumers at the expense of conventional fuel consumers.
  4. Using the Commission's estimated range of carbon savings from fuel switching gives a cost effectiveness range of £175 - £400 per tonne of carbon saved, while DTLR's estimates give a range of £325 - £1200 per tonne of carbon saved.

Purpose and Intended Effects of the Measures

  1. The main objectives of the directive are to reduce emissions of carbon dioxide from transport across Europe, and to reduce the EU's future reliance on external energy sources (in this case, oil).
  2. The proposed directive would require the UK (and other EU members) to ensure that targets for the proportion of transport fuel comprising biofuel were met by certain dates, starting in 2005. The proposed targets are set out in table 1 below. The directive does not state that the biofuel must be consumed by road vehicles, but the expression of the targets in terms of diesel and petrol sales show that road transport is the sector where change is intended. The directive would also require the UK to report annually to the Commission the sales of transport fuel and the share of biofuels in such sales[2].

Table 1: Proposed targets for biofuel use in transport

Year

Minimum amount of biofuel sold for transport, as % of petrol and diesel sold

Year Of which blended with petrol or diesel

2005

2

0

2006

2 ¾

0

2007

3 ½

0

2008

4 ¼

0

2009

5

1

2010

5 ¾

1 ¾
  1. Alongside the directive, the Commission has published a Communication on Alternative Transport Fuels which would establish a 'contact group' to advise on the further introduction of alternative fuels, particularly natural gas and hydrogen, over the next 20 years. This would consider: which types of alternative fuel vehicles might be used in the future; how refuelling infrastructure might be provided; the energy mix which would be used to provide hydrogen in the future; and what would be necessary to ensure a 5% substitution to hydrogen by 2020.

Risks

  1. Whilst all the changes that global warming could bring are not fully understood, there are widespread concerns about climate change. It is likely to have far reaching effects on all aspects of the world's environment, economy and society. The proposed directive seeks to add to measures already in place to counter climate change by reducing emissions of carbon dioxide from transport.
  2. Also, the Commission expects that EU production of oil will fall in the future, and that transport fuel demand will grow strongly, while oil production will become increasingly concentrated in the Middle East. The Commission believes that this could create a risk to the supply of energy, which encouraging a switch to fuels produced within the EU could help alleviate.

Options for Meeting the Targets

  1. As with all directives, there is no prescription of what measures should be taken to meet the proposed targets[3]. However, there seem to be three possible measures for increasing the use of biofuels:

i. duty cuts in favour of biofuels for use either in pure form or as a 'blend' with conventional transport fuels;

ii. specifying through legislation a minimum biofuel blend in conventional transport fuels; and,

iii. formalised voluntary measures with fuel producers and suppliers to meet the targets, either through selling biofuels in pure form, or as a blend.

Option 1

  1. Under this option, member states would reduce fuel duty on biofuels (by an amount of their choosing) to create a duty differential in favour of biofuels (used in either pure or blended form). This would provide an incentive to consumers to switch from conventional fuels to biofuels, through either purchasing vehicles which run on pure biofuels, or using a conventional fuel blended with a biofuel. For blended fuels, the duty reduction would apply only to the biofuel element. A separate proposed directive would provide the necessary powers for member states to make cuts to the rate of fuel duty on pure biofuels. Such a duty cut would also provide an incentive for industry to produce biofuels, although there would be uncertainty over whether the targets would be met.

Option 2

  1. This would involve amending fuel standards regulations to require fuel producers to add a minimum content of biofuel to the conventional fuel they sell. Setting the minimum content of biofuel equal to the targets in table 1 should provide a high level of certainty that the targets would be met.

Option 3

  1. These would take the form of formalised agreements between government and fuel suppliers for the latter to meet the targets, either through the sales of pure biofuels, or through blending. A successful example of this approach is the voluntary agreement between the EU and car manufacturers, whereby the manufacturers agreed to reduce the average CO2 emissions from new cars to 140g/km by 2008. There would be some flexibility in the sanctions which could be applied for non-compliance, depending on the nature of the agreement, so this option could provide more certainty that the targets would be met than a duty cut, but perhaps less certainty than a blending regulation.
  2. The Commission's Communication also suggests that the switching of Government vehicles to biofuels could be used in the short term, along with duty cuts to encourage other users also to convert their vehicles to use 100% biofuels. In the longer term, however, they believe that the scope for vehicle conversion is limited, and that the blending of biofuels with other transport fuels should be preferred.
  3. For all three options, it has been noted that blends of biofuels greater than five per cent could be problematic, as some vehicle and fuel infrastructure manufacturers' guarantees currently normally only extend to the use of no more than five per cent blends.

Benefits

The Benefits of Meeting the Targets

  1. The suggested direct benefits of reducing transport fossil fuel use include: reduced emissions of greenhouse gases; reduced risks to the security of supply of European energy; and air quality improvements.
  2. The saving in greenhouse gas emissions that would be achieved by switching transport fuels to biofuels depends on which conventional fuels are replaced, which biofuels are used, and how they are produced. Biodiesel is one biofuel for which data on potential carbon savings is available to illustrate the possible carbon impacts of switching to biofuels. The Commission suggests that the lifecycle CO2 saving is around 2 to 2½ tonnes of CO2 per 1000-litres (about 60%-80%) for biodiesel. If this were indicative of the carbon saving for biofuels generally, then achieving the 2010 target of biofuel sales equalling 5.75% of petrol and diesel sales could reduce 2010 GB road transport emissions by 2.2MtC-2.7MtC. However, the Commission's carbon saving figures are seen by some as optimistic, and DTLR lifecycle analysis suggests that a carbon saving of 20%-40% is more realistic. In that case, 2010 GB road transport emissions could be cut by 0.7MtC-1.5MtC.
  3. The UK is currently a net exporter of oil, and oil extracted by the UK is well suited to the production of transport fuel, so security of supply of oil might not appear such an immediate concern. However, as North Sea oil production is projected to decline in the near future, the UK is also expected to become a net importer of oil, so security of supply will soon become an issue for the UK too. Hence meeting the proposed biofuel targets and shifting transport fuel demand away from crude oil toward fuels produced within the EU could provide the UK with improved security of fuel supply.
  4. On the other hand, such benefits could be limited as biofuels may suffer from their own supply risks, e.g. due to variations in harvests, although the aggregate effect of global harvest variations is likely to be less. As biofuels can potentially be sourced from many parts of the world, and the fuel supply industry is already a global one, so there is no guarantee that biofuels consumed in the UK would be produced in the UK, or even the EU. It is therefore not clear that the UK's security of supply position would be significantly improved, although fuel diversity should increase.
  5. It has been suggested that switching from conventional fuels to biofuels could result in some air quality improvements. However, the evidence tends to be mixed, and it is not clear that increased use of biofuels would improve air quality significantly. Specific air quality benefits tend to depend on both the fuel type and the blending level and it is difficult to approximate their general impact. However, in general, the major biofuel types, bioethanol and biodiesel, tend to act as fuel oxygenates - helping to aid combustion of the fuel. In general, this results in lower emissions of particulates, although it can also lead to higher emissions of NOx.
  6. More generally, there is concern about the broader environmental costs and benefits of biofuels production on a large scale. Although the positive carbon contribution is a major benefit of support for biofuels, there is concern about the potential impact of large areas of intensive monoculture. Possible problems identified include impacts on biodiversity and ground water contamination from pesticide and fertiliser use. However, these impacts largely depend on the farming practices adopted, such as the degree of intensification.

Differences Between the Benefits from the Different Options

  1. As each option aims to meet the proposed targets, each option is capable of delivering the above CO2 reductions and improvements to energy supply security. However, as noted earlier, a blending regulation would seem to be the most certain method of securing the benefits, while voluntary measures appear less certain, and a biofuel duty cut less certain still.
  2. A duty cut (option 1) would also provide consumers of biofuels with a benefit in the form of lower prices. Similarly, a voluntary agreement to increase pure biofuels (option 3) would mean that fuel suppliers would need to cut biofuel prices to increase their sales, to the benefit of biofuels consumers.

Costs

Policy Costs

  1. Unlike the environmental and security of supply impacts, the costs to fuel consumers, fuel suppliers and the government of the proposed targets would depend strongly on the option used to meet them[4].
  2. According to the Commission's own estimates, biofuels are significantly more expensive to produce than conventional fuels, although the extra cost is, of course, dependent on the crude oil price. They estimate that the extra production cost of biodiesel is between 12p/l and 21p/l, assuming oil prices between $35 and $20 per barrel, respectively. The past behaviour of oil prices suggests that the upper end of this extra production cost range may be more likely than the lower, and some consultation responses suggest a higher range is more appropriate. To avoid too many ranges, though, the Commission's possibly conservative figures are used in the following analysis.
  3. Furthermore, the impact of these changes in costs would also depend on market conditions, but it would seem reasonable to treat the fuel market as fairly competitive, given that there are many fuel suppliers operating in the UK, and that fuel suppliers usually pass on to consumers promptly any changes in duties.

Option 1

  1. Using a duty cut to encourage consumers to switch to biofuels (either pure or blended) would mean that government bore the extra production costs, in the form of reduced fuel duty revenue. The size of the duty cut in favour of biofuels that would be necessary to encourage enough consumers to switch to biofuels to meet the targets is not clear. But we would not expect consumers to convert to biofuel-driven vehicles unless biofuels cost less than conventional fuels, so we can say that to cause a shift towards biofuels, the duty cut must at least equal the difference in production costs identified above. Using the Commission's figures for the extra production costs of biodiesel for illustration, assuming that such a duty cut could deliver the 5.75% biofuels target provides a lower bound to the government revenue costs from this option of £475m-£850m.

Option 2

  1. A regulation requiring a minimum blend of biofuel with conventional fuel would lead to the extra production costs of biofuels being borne by consumers of conventional fuels into which the biofuel would be blended. A 5.75% blend could therefore increase average fuel prices by 0.7p/l to 1.2p/l. Under competitive conditions, producers could pass on to consumers the full increase in costs, and a blending regulation could cost UK fuel consumers around £475m-£850m p.a., or 0.1p/km-0.2p/km on average.

Option 3

  1. If the targets were delivered through voluntary agreements in the form of voluntary blending, then the costs would be broadly the same as under the regulatory blending option. But if the producers agreed to meet the targets by increasing dedicated biofuels sales, then they would need to reduce the price of biofuels to encourage consumers to switch to them (to the same extent as under a duty cut), and also increase the price of conventional fuels to offset the costs of the biofuel price cut. The costs would then be borne by conventional fuel consumers.

Cost-Effectiveness of the Options

  1. Using the Commission's estimated range of carbon savings from fuel switching (60%-80%) with their range of extra costs gives a cost effectiveness range of £175 - £400 per tonne of carbon saved, or 12p - 21p per litre of conventional fuel saved. But using the DTLR carbon saving range (20%-40%) with the Commission's range of extra costs suggests cost effectiveness of £325-£1200 per tonne of carbon saved. These figures do not vary between options.

Compliance Costs

  1. Each option would require some form of monitoring of fuel producers' sales in order to demonstrate to the Commission that the targets were being met. This would involve fuel suppliers providing to the government records of the quantities of the different types of fuel they sold each year. Information of this kind is already supplied.
  2. Compliance would not be an issue under the biofuel duty cut option, as there would be no requirements placed upon fuel suppliers. With a blending regulation or voluntary agreement, however, fuel suppliers would need to be able to show their compliance, but as detailed regulations on fuel standards already exist, the additional administrative costs would seem unlikely to be great. And with a voluntary agreement on overall sales, fuel suppliers would need to provide only the information on overall sales required for the UK to meet the Commission's monitoring requirement mentioned above.

Compliance Regime and Sanctions

  1. Under a duty cut there would be no need for a new compliance regime, nor sanctions, as no new regulations would have been applied. But if a regulation or voluntary agreement on blending were used, then there would need to be some form of compliance monitoring and sanctions for non-compliance to ensure credibility. The information on the quantities of different fuels sold provided by fuel suppliers mentioned above should allow monitoring of compliance with a regulation or voluntary agreement, although this could be reinforced if necessary by the direct monitoring of fuel standards.

Impacts on Small Business, Charities and Voluntary Organisations

  1. The proposed targets, and all options for meeting them, affect fuel production and supply companies, which tend to be very large companies. However, small businesses, charities and voluntary organisations which consume transport fuel could be affected by any changes in fuel prices, benefiting from duty cuts or facing higher costs from biofuel blends.

Declaration

I have read the Regulatory Impact Assessment and I am satisfied that the benefits justify the costs.

Signed by the responsible Minister

.............................................................................

Date.....................................................................

1. Other possible biofuels include: biogas, biomethanol, biodimethylether, and bio-oil
2. There is also a proposed directive enabling member states to apply a differential to fuel duty in favour of biofuels, but as a tax matter this is the responsibility of HMT.
3. Although note that in the final two years, a target for blending is proposed.
4. The analysis does not account for any changes in the overall level of fuel demand under any of the options, but such an effect should be small, given the small impact on overall fuel costs.
Using £1=0.61.