Energy Security in the Renewable Fuel Standard: Reassessing Energy Security Estimates within RFS2

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1 Energy Security in the Renewable Fuel Standard: Reassessing Energy Security Estimates within RFS2 Daniel Pérez, Policy Analyst SBCA 2017 March 17, 2017

2 RFS2 Volumes Established by U.S. Congress The 2007 Energy Independence and Security Act Mandates several programs related to energy efficiency and renewable fuels RFS Key legislative provision Law requires EPA to increase U.S. biofuel use annually with the target of consuming 36 billion gallons per year by Main feedstocks in U.S. production: corn, ethanol, soy (biodiesel) 2

3 RFS2 Wide range of environmental and economic impacts Monetized impacts include: GHG Health Food Costs Energy Security ($2.6 billion estimated net benefit) 3

4 What is Energy Security? EPA: U.S. energy security is defined as protecting the U.S. economy against circumstances that threaten significant short and long term increases in energy costs [it is a] a function of the 1) stability of overall fuel supply and the 2) flexibility of demand. In short: The U.S. economy requires energy as an input to produce (Energy consumption GDP) Policy solutions focus on either Increasing stability of supply Increasing the economy s resilience to spikes (demand elasticity). *Worth noting briefly the nature of the world market for oil Nordhaus: integrated market ( world bathtub of oil ) 4

5 Methodology Used to Estimate Energy Security Benefits Oil Security Metrics Model developed by Oak Ridge National Laboratory (ORNL) Estimates energy security benefits of reduced U.S. oil use by evaluating welfare effects and energy security implications of oil imports. (Marginal benefit to society, in dollars per barrel, of reducing U.S. imports = oil premium Also important because the model is used in to inform other agency rulemaking (e.g., DOT/NHTSA CAFE standards) 5

6 Components of ORNL Model Full economic cost of importing petroleum = 1) Monopsony Effect U.S. demand for oil is large enough to affect the world price. To the extent that decreased demand lowers the world price, this results in a net welfare gain for U.S. society on each barrel of oil no longer imported. EPA uses a global value for the Social Cost of Carbon; claims benefit for reducing GHG (global) determined inconsistent excluded monopsony premium. 2) Higher price of Oil imports during shocks Higher price paid for imported oil is a welfare loss to the U.S. A portion of this is likely internalized and rests on assumptions about the % 3) Macroeconomic Disruption Cost Price shocks create both aggregate output and allocative losses. Disruption premium = marginal change in expected disruption costs. Estimate rests on key assumption of GDP disruption loss elasticity parameter. 4) Military Security and Strategic Petroleum Reserve Cost Excluded because of problem of attribution and lack of variance with changes in imports, respectively 6

7 Several Assumptions/Outcomes of ORNL Model Oil premium estimated is assumed to include only non internalized, marginal costs. A substantial portion of the disruption costs are not reflected in the market price of petroleum. (market mechanisms are assumed to be insufficient) Appropriate to estimate parameter GDP disruption loss elasticity by adjusting historical levels(1980s;.041) based on oil expenditure share in GDP. This results in an estimated GDP elasticity with a mean value of.032 (range from.01 to.054) Average disruption length 1 2 years Disruption component of oil premium estimated to be $4.87/bbl (2007$) 7

8 EPA Assumptions and Estimates in RIA of RFS2 Reduction in Dislocation Cost from Oil shocks Reduction in Dislocation Cost from Renewable Fuel Shocks Avoided Macroeconomic Dislocation Benefit Renewable Fuel Volume Mandated x Dislocation benefit/bbl = Energy security benefit $7.08/bbl $0.52/bbl $6.56/bbl ($0.94 $12.23) 403Mbbl x $6.56/bbl = $2.6 billion (2007$) EPA: extremely low (<5%) correlation between crude oil and renewable fuel feedstocks and much lower historical volatility of feedstocks effectively reduces harm to GDP during oil price spikes. This estimate is roughly $890 million higher than estimate using ORNL model. 8

9 Standalone Changes that justify revising the Oil Premium Changes in projected Oil price OPEC as a share of world production OPEC behavior Strategic Petroleum Reserve (SPR) levels Levels of other strategic reserves (EU, China, etc.) Likelihood and magnitude of disruptions Expanded supply/alternatives (tight oil, oil sands, etc.) % change of oil as an input GDP Significant change in overall economy s response 9

10 Case 1: EPA underestimates existing resilience to oil shocks EPA settled on a macroeconomic disruption premium of $6.56/bbl but its own RIA recognizes a range with values as low as $0.94. More recent literature estimates much lower security premiums as low as $1.49 in Blanchard and Gali (2007), Balke, Brown and Yücel (2008) Estimates of the security premium are heavily dependent on one s assumption about GDP disruption loss elasticity. Newer empirical research estimates a smaller effect closer to.018 Why? Research indicates that the U.S. economy currently exhibits a much different level of resilience (higher) to oil shocks vs the 70s and 80 s. Nordhaus (2007), Blanchard and Riggi (2013), McConnell and Perez Quiros (2003) Causes include: better monetary policies (government intervention or lack thereof), lower real wage rigidity Also important to note: oil futures markets, extra capacity (both private and U.S. government), slack capacity (Saudi Arabia), Other government reserves (EU, China, etc.) all ALREADY reflect a significant portion of the risks associated with oil. Result: accepting EPA s assumptions, but adjusting down the oil premium to reflect reduced risk results in an energy security benefit closer to $600 million or $391 million (if we accept EPA s estimated benefit from switching to renewable fuels). Worth noting: supply and demand elasticity assumptions are also important 10

11 Case 2: Overstating the use of biofuels as an alternative that provides substantial resilience While it s true that prices between Petroleum and Feedstock for biofuels are not highly correlated, data indicate that ethanol and gasoline prices are. O Brien (2009) Also in contrast to petroleum/gasoline it s unclear that ethanol has much (any?) surge capacity. This could result in a significantly lower estimated benefit in terms of increased resilience to the U.S. economy in the event of an oil spike. Not to mention other problems (e.g., blend wall ) 11

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