Thursday, July 1, 2010

Lit in review: 3 of 3 on Biofuels

3) Hochman, Rajagopal, and Zilberman (2010), "Are Biofuels the Culprit? OPEC, Food, and Fuel," AER Papers and Proceedings (100:May), 183-187.

A great paper. Very useful.

They expand on explanations of the recent food price spikes by including OPEC as a Cartel-of-Nations (CON) rather than a cartel of firms. A CON "maximizes the joint domestic consumer and producer surplus from crude oil." OPEC's actions change how biofuel production affects food markets, both through land allocation and energy prices. The basic insight is that OPEC reduces production (raising fuel prices) in response to growing biofuel competition, which serves to ... stabilize food market volatility by partially offsetting fuel market changes. When including this, biofuels account for 10-15 percent of the change in corn price in 2007, while lower energy prices would reduce corn, soy, wheat, and rice prices 5-10 percent and reduced demand growth from China and India would reduce corn, soy, and wheat prices by 15-20 percent and rice prices by 40 percent. Adding OPEC's reduction in oil production to the model by itself accounts for 8 percent.

When they add supply factors and lower inventories, demand factors become even more important. "Agricultural productivity is crucial and should be improved, either by improving traditional farming practices or by embracing biotechnology" (p. 187).
First generation biofuels compete with food and feed grains, which increase food prices, but to the extent they lower fuel costs, they can reduce agriculture's costs. Crude oil is a direct cost and natural gas is an indirect cost. While crude oil and food prices went up from 2002-2006, OPEC countries increased their domestic fuel subsidies. Thus, introducing biofuels leads oil-importing countries to consume less oil while oil-exporting countries consume more.

They confess that they are only considering each grain market separately. Ignoring cross-price elasticities will underestimate the impact of biofuels on prices. Other factors they mention needing to be added: speculation, domestic policies, and US dollar depreciation.

Paper that blames demand growth: Vansteenkiste 2009. Paper that blames biofuels: Mitchell 2008.

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