More Perspectives on Indirect Land Use Change Effects

AgMRC Renewable Energy Newsletter
December 2009

William K. JaegerWilliam K. Jaeger
Professor, Department of Agricultural and Resource Economics
Oregon State University

The concept of “indirect land use change effects” (ILUCs) has become a major issue for the biofuels industry and for climate change policy. ILUCs concern the connection between increasing biofuel production in one location and the effect those increases may have on expanded cultivation of land in other locations. Since clearing lands for cultivation can release large amounts of (previously sequestered) CO2 into the atmosphere, this connection may mean that the net effect of biofuel programs will be to increase CO2 emissions rather than reduce them.

There seem to be two parts to the ILUC question as it has recently been debated. The first question is, Do ILUC effects occur? And the second question is, Should biofuel producers be “held responsible” for ILUC effects if they do occur?  By looking more closely at the first question, we may also gain some insights that help address the second question.

The Importance of Indirect Market Effects

The ILUC effect is a specific kind of indirect market effect. By indirect market effect I mean the way that changes in supply or demand in one market can have effects in other markets, and where those other markets then make adjustments in response to those initial changes. Indirect market effects can occur locally, nationally, and internationally in just about any kind of market. In the case of ILUC effects, the key market is the market for land. Here’s a simplified characterization of the phenomenon: as the demand for land for biofuel production increases, the remaining land available for food production is reduced. This shift (reduction) in the supply of land for food production causes a shift (reduction) in the supply of food, and this leads to higher food prices. Higher food prices encourage food producers in other locations to increase their food production, and this in turn leads to an increase in the demand for farmland in those other locations in order to produce that additional food. The global demand for food and other agricultural products may not have changed, but its location has changed as a result of market forces and market interactions, and these are the mechanisms through which food production is shifted to other locations after having been displaced by biofuel production in the first location.

These kinds of indirect market effects are part of what makes markets efficient. Indeed, indirect market effects are a necessary part of the justification for promoting production of biofuels in the first place. Take, for example, the idea that producing biofuels reduces the use of fossil fuels. How will that happen? Well, if we produce biofuels and consumers buy them rather than buying gasoline, this reduces the demand for gasoline, which in turn will put downward pressure on gasoline prices. These lower gas prices should cause some gasoline suppliers to cut back on their orders from refineries, and these refineries will similarly reduce their orders from oilfields. It is through these kinds of indirect market effects that we assume that if we produce biofuels this will lead to a reduction in the extraction of oil from the ground somewhere, perhaps in an OPEC country, and that this will lower our use of fossil fuels. None of this would happen, however, without the kinds of indirect market effects just described. If oil producers, transporters, and refiners are not influenced by indirect market effects (starting with the shift in demand from gasoline to biofuels), then we can’t assume that biofuels have any effect on fossil fuel use or energy security. In fact, the common assumption of a ‘gallon-for-gallon’ substitution of biofuel for gasoline will overstate the true effect. One well-known reason for this is that ethanol has less energy per gallon than a gallon of gasoline, but aside from that difference another reason is that if increased use of ethanol lowers the demand and thus the price of gasoline, the resulting drop in gasoline prices will actually lead to a (small) increase in gasoline consumption because driving becomes less expensive.

Let’s take another example that is more similar to the ILUC case because it involves a secondary market rather than the biofuel/gasoline market itself. The ILUC effect involves the market for an input, land, and how the demand and supply of land in different markets is affected by biofuel production. Another secondary market affected by biofuel production is the livestock feed market. Most analyses of the “net energy” effects of biofuel production take account of the energy content of the byproducts such as distillers dry grains with solubles (DDGS) or soy meal. Giving an energy “credit” to biofuels because of the energy in the DDGS that is produced as a byproduct makes no sense unless you recognize an indirect market effect. The indirect market effect goes something like this: When biofuel production results in an amount of DDGS being produced, the DDGS enters the animal feed market. This additional supply of animal feed causes feed prices to decline, and we expect other animal feed producers to slow their production as a result of this price decline. This, in turn, means that they will use less energy in the production of non-biofuel sources of animal feed. The DDGS from corn ethanol thus causes indirect market effects that reduce energy use elsewhere, and so these energy savings are “credited” to biofuels.

In this way, a DDGS energy “credit” for biofuels is actually very similar to assigning CO2 “blame” for ILUCs. We can’t be sure that the biofuel co-products like DDGS will have these energy effects, but this has been the standard assumption that the energy content of the co-products will not end up in a landfill, and so a full credit for all of the energy in the co-product is usually given in the energy accounting because it will displace other energy inputs.

So if we recognize the indirect market effect in order to conclude that biofuels lower use of fossil fuels, and if we recognize the indirect market effects in order to give an “energy credit” for DDGS, then it only makes sense to also recognize the indirect market effects that are transmitted via farmland and food markets to ILUCs. It may be that there is more uncertainty about the location and magnitude of the ILUCs compared to the indirect effects of DDGS on energy use in animal feed markets, but the effects should not be ignored or dismissed. At the same time, we need to understand that the inevitable uncertainty when estimating indirect market effects means that they may be bigger or smaller than our current best estimates.

Who is Responsible?

The issue here is not really about holding anybody “responsible” for these effects. These are all market realities. It is about how markets work and how market forces are transmitted across locations and around the world. Unless we repeal the laws of supply and demand, people will continue to want to eat food, and if we take land out of food production to grow biofuel feedstocks in one location, that food (or other agricultural product) will need to be grown somewhere else.

Another way to look at it is to recognize that biofuel feedstock production requires land, and that this represents a “new demand” for farmland, meaning “new lands” will need to be farmed. The feedstocks themselves may not be farmed on “new land,” but by taking land out of food production, and displacing the food production in one location, there are ripple effects, or indirect market effects that result in new lands being cultivated somewhere else. Depending on how much carbon is stored in these lands, whether they are forests or grasslands, there will be implications for carbon emissions that are potentially large.

How big or small are ILUCs?

To say anything specific about the size of these effects we need to estimate how these indirect market effects will occur, where these new lands will be brought into cultivation, and how much carbon will be emitted when they are cleared and cultivated. That is a difficult and complex set of interconnections to try and understand. There are a number of global economy computer models that have been used to evaluate the complex interconnections among markets, and evaluate the net effect from ILUCs. The “GTAP” model developed at Purdue University is one such model that has been used to evaluate US trade agreements and the effects of the farm bill. Most of the major research that has been carried out on the topic has so far concluded that ILUCs generate carbon emissions that are larger than the carbon savings from using biofuels instead of fossil fuels.

Can ILUCs be Minimized?

Certainly more research is needed to be more confident about those estimates, and to better understand the scope for reducing them. ILUCs cannot be ignored and they can probably not be completely eliminated: we cannot repeal the laws of supply and demand. But there are things that could possibly be done to reduce their magnitude. Biofuel production policies could be structured to reduce the amount of land diverted from food production. The most carbon-rich tropical forests could be better protected from encroachment that is caused in part by higher food prices (shifting ILUCs to other lands that currently store less carbon). Biofuels could be grown on “marginal lands” that are not used for food production, and where also the carbon emissions from disturbing these lands would be relatively small. All of these efforts to reduce the magnitude of ILUCs come at a cost, however, and so the trade-off between the cost of biofuels and their effectiveness at lowering greenhouse gas emissions and energy goals needs to be part of the policy debate.

Keep the Focus on the Pertinent Question

Some observers point out that there are other causes of deforestation, other actions that cause higher food prices, other sources of CO2 emissions, etc. If we are asking the question, how can we reduce CO2 emissions?, then all of these issues could be looked at, including looking at their costs. Addressing these other issues may be good ideas on their own merits. In the case of biofuels, however, the point is that the main reason for promoting and subsidizing biofuels it because of the belief that they will help achieve our energy and environmental goals, including addressing climate change. So that is why ILUCs are particularly relevant to biofuels: if large enough, ILUC effects can completely undermine one of the main intended goals of biofuels. By contrast other government programs may have negative side effects such as ILUCs, and if so these should be taken into account. But if the main objective of those other policies is not aimed at reducing carbon emissions, then an ILUC may not threaten the main justification for those programs.

Some observers also point out that even with projected increases in corn ethanol production in the U.S., food exports from the U.S. are expected to continue to be positive, in part because of projected future yield increases. But, again, if we want to evaluate biofuels, we should focus on the changes that occur as a result of biofuel production and consumption: changes in energy use (both direct and indirect effects), changes in greenhouse gas emissions (both direct and indirect effects). We shouldn’t confuse what we expect to happen as a result of biofuel promotion with what we expect to happen no matter what. We want to try and understand how a world “with” biofuels would differ from a world “without” biofuels – that is the way we can identify the impacts of biofuels. Sometimes this important “with and without” comparison is confused with a “now versus later” comparison. There may be other trends we expect to see in the future, trends in yields, trends in prices, trends in population, trends in deforestation. Expected world demand for grains and expected world supply of grains will lead to different levels of production, prices and different land use scenarios depending on how much biofuel production growth is assumed to occur in coming years. But asking whether there will be “room for biofuels without an ILUC impact” won’t answer the right question about ILUCs. The right question is, How much more land will be cultivated in a world “with” biofuels compared to a world “without” biofuels, or perhaps more correctly a world with less biofuels? The additional carbon emissions that will occur as a result of increased biofuel production is answered by comparing the “with” scenario to the “without” (or with less) scenario.

The Bottom Line

Biofuel production has indirect market effects. Some of those effects will reduce our use of fossil fuels, some will mean less energy is needed in animal feed production, and some (ILUCs) will expand land clearing and cultivation, which in turn may increase carbon emissions. We can’t really pick and choose which of these we acknowledge as being legitimate consequences of biofuel production. From an economic and policy analysis perspective, the focus should be on how large or small each of these effects will be. If ILUCs occur and they are estimated to be large, then this weakens the rationale behind biofuels as a way to slow climate change; if they are small or can be made smaller by policy or technology, then this is also very important to recognize and explore further. But we need to evaluate all of these effects by doing a “with versus without” comparison and estimating as best we can the energy, fossil fuel, cost, and greenhouse gas implications in the “with” scenario compared to the “without” scenario. The question of whether ILUCs “count” when deciding if biofuels should be considered “low carbon” energy sources for a particular law or regulation will, no doubt, also have political dimensions.