Alternative Programs to Incentivize Investment in U.S. Cellulosic Biofuel Refining Infrastructure
Investors in cellulosic biofuel processing face high capital and start-up costs, particularly the early entrants to the industry. Commercialization will require providing the necessary economic, legal, and/or political incentives for fuel producers to make significant capital investments in building processing facilities, and farmers to begin growing feedstocks to supply them. This project is analyzing loan guarantee programs, designing innovative insurance programs, and evaluating the potential for private market derivatives that would provide potential refiners with funding sources and risk management tools to encourage investment. Government loan guarantees, insurance programs, and private market derivative instruments are being studied as options to achieve targeted production capacity levels for the industry to meet RFS2 mandate levels within the next 5 years.
The focus of this project is to analyze the investment decision facing potential investors in cellulosic biofuels, and to evaluate the effectiveness of various policy mechanisms which could be used to promote investment in the industry. The modeling effort of the project utilizes a real options framework. We incorporate existing biofuel policies into the model, namely the Renewable Fuel Standard mandate and related regulations and government loan guarantee programs, as well as alternative policy mechanisms such as directed government expenditures on research and development of cellulosic processing technologies. Results show that existing policies have a smaller impact on encouraging investment in cellulosic capacity than the investor’s expectations for 1) future technology improvements and breakthroughs, and 2) internal learning effects which can improve future profit margins. Furthermore, government research and development expenditures may actually lead to additional delays in investment if they lead investors to believe that future technological breakthroughs will become more likely. Significant advances which reduce capital and operating costs or increase expected profitability are needed before significant investment activity will occur in the cellulosic processing industry.
Investors in cellulosic biofuel processing face high capital and start-up costs, particularly the early entrants to the industry. These costs are expected to decline significantly as the technology matures and through knowledge spillovers. Moving towards commercialization will require providing the necessary economic, legal, and/or political incentives for 1) fuel producers to make significant capital investments in building processing facilities, and 2) farmers to begin growing feedstocks to supply the processing facilities. The objectives of this project are to analyze the investment decision, and the policy and market tools that could encourage investment in cellulosic processing capacity.
This project is addressing the large amount of risk and uncertainty facing potential investors in the cellulosic biofuel refining industry. Large capital costs, continually emerging and evolving technological processes, the lack of developed feedstock markets, energy market volatility, and uncertain renewable energy policy are all factors causing refiners to delay investment decisions into the future. Our project has developed a real-options model that incorporates these factors into a refiner’s investment decision.
The theoretical framework illustrates the motivations for delaying investment – namely that investment and production costs are expected to decline through time from research and innovation, as well as learning-by-doing within the industry and firms. The numerical model is then used to show how policy tools, such as loan guarantee and insurance programs, can reduce the length of time until refiners are willing to invest in cellulosic refining capacity. Both the theoretical and numerical models also address the externalities driven by the social benefits of reduced greenhouse gas emissions associated with biofuels. Consideration of this externality both motivates and justifies the use of policy to encourage and facilitate investment in cellulosic processing.
Published in 2012
A Real Options Model of Investment in Cellulosic Ethanol, Fanglin Ye and N. D. Paulson. paper submitted to the Agricultural and Applied Economics Association’s 2013 Annual Meetings, Washington, DC.
RIN Stock Update: Implications of the 2012 Drought, N. D. Paulson, farmdocDaily post, December 14, 2012.
The Nested Structure of the RFS2 Biofuel Mandate and RIN Values, N. D. Paulson, farmdocDaily post, September 20, 2012.
RIN Values: What Do They Tell Us about the Impact of Biofuel Mandates, S. Meyer and N. D. Paulson, farmdocDaily post, September 6, 2012.
An Update on RIN Stocks and Implications for Meeting the RFS2 Mandates with Corn Ethanol, N. D. Paulson and S. Meyer, farmdocDaily post, August 1, 2012.
Optimal Contracts to Induce Biomass Production Under Risk, X. Yang, N. D. Paulson, and M. Khanna. paper presented at the Agricultural and Applied Economics Association’s 2012 Annual Meetings, Seattle, WA.
A Theory of Dynamic Biofuel Tax Credit, F. Ye, L. Lu, and X. Du, paper presented at the Agricultural and Applied Economics Association’s 2012 Annual Meetings, Seattle, WA.