Sustained high world oil prices and the passage of the EPACT2005 have encouraged the use of agriculture-based ethanol and biodiesel in the transportation sector; however, both the continued growth of the biofuels industry and the long-term market potential for biofuels depend on the resolution of critical issues that influence the supply of and demand for biofuels. For each of the major biofuels—corn-based ethanol, cellulosic ethanol, and biodiesel—resolution of technical, economic, and regulatory issues remains critical to further development of biofuels in the United States. 

In the transportation sector, ethanol is the most widely used liquid biofuel in the world. In the United States, nearly all ethanol is blended into gasoline at up to 10 percent by volume to produce a fuel called E10 or “gasohol.” In 2005, total U.S. ethanol production was 3.9 billion gallons, or 2.9 percent of the total gasoline pool. Preliminary data for 2006 indicate that ethanol use rose to 5.4 billion gallons. Biodiesel production was 91 million gallons, or 0.21 percent of the U.S. distillate fuel oil market, including diesel, in 2005 (Table 11). All cars and light trucks built for the U.S. market since the late 1970s can run on the ethanol blend E10. Automakers also produce a limited number of FFVs for the U.S. market that can run on any blend of gasoline and ethanol up to 85 percent ethanol by volume (E85). Because auto manufacturers have been able to use FFV sales to offset CAFE requirements, more than 5 million FFVs were produced for the U.S. market from 1992 through 2005. E10 fuel is widely available in many States. E85 has limited availability, at stations clustered mostly in the midwestern States. 

In the AEO2007 reference case, ethanol use increases rapidly from current levels. Ethanol blended into gasoline is projected to account for 4.3 percent of the total gasoline pool by volume in 2007, 7.5 percent in 2012, and 7.6 percent in 2030. As a result, gasoline demand increases more rapidly in terms of fuel volume (but not in terms of energy content) than it would in the absence of ethanol blending. Overall, gasoline consumption is projected to increase by 32 percent on an energy basis, and by 34 percent on a volume basis, from 2007 to 2030. 

Ethanol can be produced from any feedstock that contains plentiful natural sugars or starch that can be readily converted to sugar. Popular feedstocks include sugar cane (Brazil), sugar beets (Europe), and maize/corn (United States). Ethanol is produced by fermenting sugars. Corn grain is processed to remove the sugar in wet and dry mills (by crushing, soaking, and/or chemical treatment), the sugar is fermented, and the resulting mix is distilled and purified to obtain anhydrous ethanol. Major byproducts from the ethanol production process include dried distillers’ grains and solubles (DDGS), which can be used as animal feed. On a smaller scale, corn gluten meal, gluten feed, corn oil, CO₂, and sweeteners are also byproducts of the ethanol production process used in the United States. 

With additional processing, plants and other biomass residues (including urban wood waste, forestry residue, paper and pulp liquors, and agricultural residue) can be processed into fermentable sugars. Such potentially low-cost resources could be exploited to yield significant quantities of fuel-quality ethanol, generically termed “cellulosic ethanol.” Cellulose and hemicellulose in biomass can be broken down into fermentable sugars by either acid or enzymatic hydrolysis. The main byproduct, lignin, can be burned for steam or power generation. Alternatively, biomass can be converted to synthesis gas (hydrogen and carbon monoxide) and made into ethanol by the Fischer-Tropsch process or by using specialized microbes. 

Capital costs for a first-of-a-kind cellulosic ethanol plant with a capacity of 50 million gallon per year are estimated by one leading producer to be $375 million (2005 dollars) [131], as compared with $67 million for a corn-based plant of similar size, and investment risk is high for a large-scale cellulosic ethanol production facility. Other studies have provided lower cost estimates. A detailed study by the National Renewable Energy Laboratory in 2002 estimated total capital costs for a cellulosic ethanol plant with a capacity of 69.3 million gallons per year at $200 million [132]. The study concluded that the costs (including capital and operating costs) remained too high in 2002 for a company to begin construction of a first-of-its-kind plant without significant short-term advantages, such as low costs for feedstocks, waste treatment, or energy. 

If future oil prices follow a path close to that in the AEO2007 reference case, significant reductions in the capital cost and operating costs of a cellulosic ethanol plant will be needed for cellulosic ethanol to be economically competitive with petroleum-based fuels. The extent to which costs can be reduced through a combination of advances in the production process for cellulosic ethanol and learning as plants are constructed in series will be important to the future competitiveness of cellulosic ethanol. World oil price developments also will play a central role. 

Currently, no large-scale cellulosic ethanol production facilities are operating or under construction. EPACT2005 provides financial incentives that in the AEO2007 reference case are projected to bring the first cellulosic ethanol production facilities on line between 2010 and 2015, with a total capacity of 250 million gallons per year. Cellulosic ethanol currently is not cost-competitive with gasoline or corn-based ethanol, but considerable R&D by the National Renewable Energy Laboratory and its partners has significantly reduced the estimated cost of enzyme production. Although technological breakthroughs are inherently unpredictable, further significant successes in R&D could make cellulosic ethanol a viable economic option for expanded ethanol production in the future. 

Biodiesel is a renewable-based diesel substitute used in Europe with early commercial market development in the United States. Biodiesel is composed of mono-alkyl esters of long-chain fatty acids derived from vegetable oils or animal fats [133]. It is similar to distillate fuel oil (diesel fuel) and can be used in the same applications, but it has different chemical, handling, and combustion characteristics. Biodiesel can be blended with petroleum diesel in any fraction and used in compression-ignition engines, so long as the fuel system that uses it is constructed of materials that are compatible with the blend. The high lubricity of biodiesel helps to offset the impact of adopting low-sulfur diesel. 

Common blends of biodiesel are 2 percent, 5 percent, and 20 percent (B2, B5, and B20). Individual engine manufacturers determine which blends are warranted for use in their engines, but generally B5 blends are permissible and some manufacturers support B20 blends. Blends of biodiesel are distributed at stations throughout the United States. Some States have mandated levels of biodiesel use when in-State production reaches prescribed levels. 

Predominant feedstocks for biodiesel production are soybean oil in the United States, rapeseed and sunflower oil in Europe, and palm oil in Malaysia. Biodiesel also can be produced from a variety of other feedstocks, including vegetable oils, tallow and animal fats, and restaurant waste and trap grease. To produce biodiesel, raw vegetable oil is chemically treated in a process called transesterification. The properties of the biodiesel (cloud point, pour point, and cetane number) depend on the type of feedstock used. Crude glycerin, a major byproduct of the reaction, usually is sold to the pharmaceutical, food, and cosmetic industries. 

Energy Content and Fuel Volume 

On a volumetric basis, ethanol and biodiesel have lower energy contents than do gasoline and distillate fuel oil, respectively. Table 12 compares the energy contents of various fuels on the basis of Btu per gallon and gallons of gasoline equivalent. The table shows both the low heating value (the amount of heat released by the fuel, ignoring the latent heat of vaporization of water) and the high heating value (the amount of heat released by the fuel, including the latent heat of vaporization of water). The lower energy content of ethanol and biodiesel generally results in a commensurate reduction in miles per gallon when they are used in engines designed to run on gasoline or diesel. Small-percentage blends of ethanol and biodiesel (E10, B2, and B5) result in smaller losses of fuel economy than do biofuel-rich blends (E85 and B20). 

Today, most fuel ethanol is used in gasoline blends, where it accounts for as much as 10 percent of each gallon of fuel—a level that all cars can accommodate. In higher blends, ethanol can make up as much as 85 percent of each gallon of fuel by volume. In the future, increased use of ethanol as a transportation fuel will raise the issue of fuel volume versus energy content. Ethanol contains less energy per gallon than does conventional gasoline. A gallon of ethanol has only two-thirds the energy of a gallon of conventional gasoline, and the number of miles traveled by a given vehicle per gallon of fuel is directly proportional to the energy contained in the fuel. 

E10 (10 percent ethanol) has 3.3 percent less energy content per gallon than conventional gasoline. E85 (which currently averages 74 percent ethanol by volume) has 24.7 percent less energy per gallon than conventional gasoline. AEO2007 assumes that engine thermal efficiency remains the same whether the vehicle burns conventional gasoline, E10, or E85. This means that 1.03 gallons of E10 or 1.33 gallons of E85 are needed for a vehicle to cover the same distance that it would with a gallon of conventional gasoline. Although the difference is not expected to have a significant effect on purchases of E10, AEO2007 assumes that motorists whose vehicles are able to run on E85 or conventional gasoline will compare the two fuels on the basis of price per unit of energy. 

The issue of gasoline energy content first arose in the early 1990s with the introduction of oxygenated gasoline made by blending conventional gasoline with 15 percent MTBE or 7.7 percent ethanol by volume. When oxygenated gasoline was introduced, MTBE was the blending agent of choice. Since then, ethanol has steadily replaced MTBE in oxygenated and RFG blends. The fuel economy impact of switching from MTBE-blended gasoline to an ethanol blend is smaller than the impact of switching from conventional gasoline. For example, changing from 15 percent MTBE to 7.7 percent ethanol in blended gasoline results in a reduction in energy content of only 1.2 percent per gallon of fuel, and changing from 15 percent MTBE to 10 percent ethanol results in a reduction of 1.9 percent. 

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Current State of the Biofuels Industry 

The nascent U.S. biofuel industry has recently begun a period of rapid growth. Over the past 6 years, biofuel production has been growing both in absolute terms and as a percentage of the gasoline and diesel fuel pools (see Table 11). High world oil prices, firm government support, growing environmental and energy security concerns, and the availability of low-cost corn and soybean feedstocks provide favorable market conditions for biofuels. Ethanol, in particular, has been buoyed by the need to replace the octane and clean-burning properties of MTBE, which has been removed from gasoline because of concerns about groundwater contamination. About 3.9 billion gallons of ethanol and 91 million gallons of biodiesel were produced in the United States in 2005. According to estimates based on the number of plants under construction, ethanol production capacity could rise to about 7.5 billion gallons and biodiesel capacity to about 1.1 billion gallons by 2008, possibly resulting in excess capacity in the near term (Figure 22). 

The American Jobs Creation Act of 2004 established and extended blender’s tax credits to reduce the final cost (in nominal terms) of pure ethanol by $0.51 per gallon, biodiesel made from virgin oil by $1.00 per gallon, and biodiesel made from waste grease by $0.50 per gallon [134]. The national RFS legislated in EPACT2005 provides biofuels with a reliable market of at most 7.5 billion gallons annually by 2012. Ethanol fuel is expected to fulfill most of the RFS requirement. 

In the AEO2007 reference case, ethanol demand is projected to exceed the applicable RFS requirements between now and 2012, because of the need for ethanol as a fuel oxygenate to meet Federal gasoline specifications and as an octane enhancer and because of the blender’s tax credit. Ethanol consumption is projected to rise to 11.2 billion gallons, representing 7.5 percent of the gasoline pool, by volume, in 2012. Current and projected real oil prices far above those experienced during the 1990s, coupled with the availability of significant tax incentives and the RFS requirement have created a favorable market for biofuels. Accelerated investments in biofuel production facilities and rapid expansion of existing capacity underscore the attractiveness of biofuel investments. 

Short-run production costs, which include feedstock costs, cash operating expenses, producer subsidies, and byproduct credits but exclude capital costs, transportation fees, tax credits, and fuel taxes, vary considerably according to plant size, design, and feedstock supply. Assuming corn prices of about $2 per bushel and excluding capital costs, corn-based ethanol can be produced by the dry-milling process for approximately $1.00 to $1.06 per gallon (2005 dollars) or $11.90 to $12.60 per million Btu [135, 136]. Corn prices spiked to well above that level in 2006 because of tightness in the supply-demand balance for corn, caused by farmers’ removing about 3 million acres from corn production and using it for soybean production instead. 

Biodiesel can be produced from soybean oil for $1.80 to $2.40 per gallon ($15.20 to $20.30 per million Btu) and from yellow grease for $0.90 to $1.10 per gallon ($7.60 to $9.30 per million Btu) [137, 138]. Feedstock costs for virgin soybean oil, which are dictated by commodity markets and vary between $0.20 and $0.30 per pound, constitute 70 to 78 percent of final production costs. Non-virgin feedstocks generally are cheaper, ranging from virtually no cost (for reclaimed restaurant trap grease) to 70 percent of the final production cost. For the production costs calculated above, virgin soybean oil was assumed to cost $0.26 per pound, and yellow grease was valued at 50 percent of the cost of an equivalent amount of soybean oil. 

When the blender’s tax credit for ethanol and biodiesel is subtracted from the wholesale prices (which include capital recovery and transportation fees), biofuels are price competitive with petroleum fuels on a volumetric basis [139]. Figure 23 compares the rack price of ethanol (including the blender’s tax credit) with the price of unleaded gasoline. The “rack price” is defined as the wholesale price of ethanol fuel where title is transferred at the terminal. 

Profitability in the biofuels industry depends heavily on the cost of feedstocks. For ethanol, corn feedstock made up nearly 57 percent of the total production cost in 2002 [140]. For biodiesel, soybean oil makes up 70 to 78 percent of the total production cost [141, 142]. Fluctuations in the price of either feedstock can have dramatic effects on the production costs, and the industry assumes considerable market risk by relying on a limited array of feedstocks. 

The U.S. ethanol industry relies almost exclusively on corn, consuming 20 percent of the available corn supply in 2006 [143]. At current production levels, corn— which is produced domestically in large volumes—is the most attractive feedstock for ethanol. As ethanol production increases, competition for corn supplies among the fuel, food, and export markets, along with a decline in the marginal value of ethanol co-products, is expected to make production more expensive [144]. 

Assuming the development of cost-effective production facilities, cellulosic biomass feedstocks like switchgrass, agricultural residues, and hybrid poplar trees could supply a growing ethanol industry with large quantities of less expensive raw materials. To differentiate the current use of corn with the future use of cellulosic biomass and the differences in production technology, corn is generally characterized as a “first generation” energy crop, whereas switchgrass and other cellulosic materials are “second generation” energy crops. 

The U.S. biodiesel industry relies almost exclusively on soybean oil as a feedstock. Soybean oil has historically been a surplus product of the oilmeal crushing industry, available in large quantities at relatively low prices. At production levels nearing 300 to 600 million gallons of biodiesel per year (less than 2 percent of the diesel fuel pool), the marginal cost of using soybean oil as a feedstock rises to the point where other oilseeds—canola, rapeseed, sunflower, and cottonseed—become viable feedstocks [145]. There are no significant differences in processing for the numerous biodiesel feedstocks, and they cannot easily be grouped into first- and second-generation categories. The major differences among biodiesel feedstocks are regional availability, co-product value, and the composition of fatty acids in the refined vegetable oil. 

Resource Utilization and Land Availability 

Currently, corn and soybean feedstocks for biofuels are grown almost exclusively on prime agricultural land in the Midwest. Increases in the supply of biofuel feedstocks could come from a combination of three strategies: increasing the amount of land used as cropland, boosting the yields of existing energy crops, and replacing or supplementing corn with cellulosic biomass and soybeans with oilseeds more appropriate for biodiesel production. All three strategies may be required to overcome the constraints of currently available feedstocks and sustain biofuel production levels that could displace at least 10 percent of gasoline consumption. 

According to the most recent Agricultural Census (2002), the amount of cropland available in the lower 48 United States is 434 million acres [146], or 23 percent of the total land area [147]. The total amount of cropland—defined as the sum of land used for crops, idle land, and pasture—has been declining for the past 50 years and, increasingly, is becoming concentrated in the Midwest. The trend is expected to continue as population pressure leads to permanent conversion of some agricultural lands to other uses. It is unlikely that additional cropland will be added in the United States to accommodate increases in the demand for biofuels. Instead, the cultivation of biofuels will compete with other agricultural uses, such as pastureland and idle land, much of which is in the Conservation Reserve Program (CRP) [148]. 

The potential use of CRP acreage to grow corn and soybeans is constrained by productivity, environmental, and contractual limitations. Nevertheless, there may be significant opportunities in the future to use some CRP acres to grow such “low-impact” energy crops as native grasses (switchgrass) and short-rotation trees (willows or poplars) to generate cellulosic biomass. Pilot programs are underway in Minnesota, Iowa, New York, and Pennsylvania to determine whether CRP acres can be used to grow energy crops while preserving the environmental mandate of the CRP. 

Land Use and Productivity 

With a limited supply of cropland available for biofuel feedstocks, increasing yield (bushels per acre) on an annual basis could significantly boost available supplies of corn and soybeans without requiring additional land. With more than 81 million acres devoted to corn and nearly 72 million acres devoted to soybeans (2005 U.S. planted acres), even small increases in annual yield could boost supplies significantly [149]. 

There have been large annual increases in yields of both corn and soybeans over the past 30 years. Corn yields increased from 86.4 bushels per acre in 1975 to 151.2 bushels per acre in 2006, and soybean yields increased from 28.9 bushels per acre to 43 bushels per acre over the same period [150]. If corn yields continue to increase at the same rate (approximately 1.8 bushels per acre per year), production could increase by more than 3.1 billion bushels (29 percent) by 2030 without requiring any additional acreage. Similarly, soybean production could increase by nearly 1.0 billion bushels per year by 2030 with no additional acreage requirement if yields continue to grow at the rate of 0.5 bushels per acre per year [151]. Improvements in biofuel collection and refining and bioengineering of corn and soybeans also could contribute to improved biofuel yields. Research on methods to increase the starch content of corn and the oil content of soybeans is also ongoing. 

Crop Competition 

A key uncertainty is the availability of sufficient land resources for large-scale expansion of the cultivation of biofuel crops, given the intense competition with conventional agricultural products for arable land. Competition will favor those crops most profitable for farmers, accounting for such factors as growing region, farming practice, and soil type. Currently, corn and soybeans are competitive energy crops, because they provide high value to farmers at prices low enough to allow the biofuel industry to produce a product competitive with petroleum fuels. 

Cellulosic biomass from switchgrass, hybrid willow and poplar trees, agricultural residues, and other sources has significant supply potential, possibly up to 4 times the potential of corn [152]. Switchgrass and poplars could be grown on CRP lands, where corn cannot be grown economically, but they would not be competitive with corn until corn prices rose or the capital and non-feedstock production costs of cellulosic ethanol were significantly reduced. To expand beyond a production level of 15 to 20 billion gallons per year without seriously affecting food crop production and prices, the industry must make a transition to crops with higher yields per acre and grow crops in an environmentally permissible manner on CRP lands, while continuing to provide profits for producers. 

Role of Co-products in Biofuel Economics 

The value of co-products will play a significant role in determining which crops are most profitable for farmers to grow and biofuel producers to use. High prices for raw crop material are desirable for farmers but undesirable for biofuel producers. High prices for co-products, on the other hand, increase revenues for agricultural processors, sustain high prices for raw crop materials, and offset feedstock costs for biodiesel producers. Corn and soybeans not only provide starch and oil for biofuel production but also generate significant quantities of co-products, such as DDGS, gluten feed, gluten meal, corn oil, and soybean oil meal with high protein content (Table 13). As a result, corn grain and soybean oil can be offered at prices lower than those of other feedstocks, and currently they are the most competitive biofuel crops. 

Co-products of the 3.9 billion gallons of ethanol produced in 2005 were significant, including 10 million short tons of DDGS, 473,000 short tons of corn gluten meal, 2.6 million short tons of corn gluten feed, and 283,000 short tons of corn oil [153]. As biofuel production continues to expand to the level of 7.5 billion gallons per year mandated in EPACT2005, production of DDGS, used primarily as animal feed, will grow to more than 12 million short tons annually and may depress prices in the feed market. 

Biodiesel production in 2005 was considerably less than ethanol production, at 90.8 million gallons. Because U.S. biodiesel production currently uses surplus soybean oil (generated as a co-product in the soybean meal industry), it has little effect on other markets for soybeans; however, annual production of 300 to 600 million gallons of biodiesel would begin to compete with food and feed markets for soybeans [154]. For every 100 pounds of biodiesel production, about 10 pounds of crude glycerin is generated as a co-product [155]. The glycerin generated by a 300 to 600 million gallon per year biodiesel industry could displace nearly one-half of the 692 million pounds of glycerin produced domestically in North America [156] and result in substantial oversupply. 

Market Effects of Biofuel Growth 

The feedstocks used to produce biofuels currently make up only 15 percent of available crop matter and are located at the end of a long agricultural supply chain. The markets for biofuels, biofuel co-products, and crop commodities are linked and susceptible to changes in the prices and availability of crops. Surging demand for biofuel feedstocks is likely to exert upward price pressure on corn and soybean commodities and influence export, food, and industrial feedstock markets, particularly in the short term. 

Co-product production also increases with biofuel production. At higher levels of biofuel production in the future, co-products may be oversupplied, resulting in depressed prices for the co-products and lower revenues from their sale to offset fuel production costs. Finding new, high-value uses for co-products could ensure that market prices for co-products remain stable. To the extent that other energy crops, such as switchgrass and inedible oilseeds, could be grown on less productive land (like the CRP), upward pressure on the prices of corn, soybeans, and other high-value food crops could also be mitigated. 

Some studies have suggested that up to 16 billion gallons of ethanol (slightly more than 10 percent of the total gasoline pool by volume) can be produced from corn in 2015 without adversely affecting the price of corn and upsetting domestic food, feed, and export markets [157]. A growing corn supply—the result of increasing yields and relatively slow growth in the demand for corn in the food, feed, and export markets— contributes to stable corn prices [158]. Between 33 and 38 percent of domestic corn production would be needed to produce 12 to 16 billion gallons of ethanol in 2015/2016, as compared with the 14.6 percent of domestic production that was used for ethanol feedstocks in 2005 [159]. 

Biofuel Distribution Infrastructure 

Another issue that could limit the growth of the U.S. biofuels industry is development of the necessary infrastructure for collecting, processing, and distributing large volumes of biofuels. Currently, nearly all U.S. biofuel production facilities are located close to corn and soybean acreage in the Midwest, minimizing the transportation costs for bulky, unrefined materials. The facilities are far from the major biofuel consumption centers on the East and West Coasts. Further complicating matters is the fact that biodiesel and ethanol cannot be blended at the refinery and batched through existing pipelines. Ethanol can easily be contaminated by water, and biodiesel dissolves entrained residues in the pipelines. As a result, railroad cars and tanker trucks made from biofuel-compatible materials are needed to transport large volumes of biofuels to market. 

Limited rail and truck capacity has complicated the delivery of ethanol, contributing to regional ethanol supply shortages and price spikes between April and June 2006. Feedstock and product transportation costs and concerns remain problematic for the biofuel industry and have led many biofuel producers to explore the prospect of locating near a dedicated feedstock supply or large demand center to minimize transportation costs and susceptibility to bottlenecks. 

Distribution of biofuels to end-use markets is also hampered by a number of other factors. Although E10 is readily obtainable throughout the United States, there are limited numbers of fueling stations for biodiesel and E85 (Table 14). Further, some station owners may be averse to carrying B20 or E85, because the unique physical properties of the blends may require costly retrofits to storage and dispensing equipment. 

Recent EIA estimates for replacing one gasoline dispenser and retrofitting existing equipment to carry E85 at an existing fueling station range from $22,000 to $80,000 (2005 dollars), depending on the scale of the retrofit. Some newer fueling stations may be able to make smaller upgrades, with costs ranging between $2,000 and $3,000. Investment in an E85 pump that dispenses one-half the volume of an average unleaded gasoline pump (about 160,000 gallons per year) would require an increase in retail prices of 2 to 7 cents per gallon if the costs were to be recouped over a 15-year period. The costs would vary, depending on annual pump volumes and the extent of the station retrofit. The installation cost of E85-compatible equipment for a new station is nearly identical to the cost of standard gasoline-only equipment. 

Independent station owners may also be uncomfortable with the relative novelty of biofuels and the murky regulatory environment that surrounds their use and distribution at retail locations. For gasoline outlets operated by major distributors, owners are more likely to be aware of the environmental regulations and more willing to seek appropriate permits when confronted with favorable biofuel economics. Awareness of various biofuels is limited, and station operators will need to post appropriate labels, placards, and warning signs to ensure that customers put the appropriate fuels in their vehicles. With the rapid growth and change in the biofuels industry, quality control programs are also critical to ensure that biofuels meet accepted quality specifications from the American Society for Testing and Materials for ethanol (ASTM D4806) and biodiesel (ASTM D6751). 

Consumer Demand, Awareness, and Attitudes 

Biofuel production capacity is expanding rapidly in response to heightened market demand resulting from high petroleum prices, favorable tax incentives, and consumer concerns over environmental and energy security issues. The market potential for biofuel blends (E10, B5, and B20) remains significantly larger than current production levels and will continue to absorb the biofuel supply for the foreseeable future (Table 15). Consumer behavior, however, will play an increasingly important role in determining demand for biofuels. Consumer attitudes about fuel prices, relative fuel performance, biofuel-capable vehicles, and the environment will affect the volume and type of biofuels sold. 

Price, availability, and familiarity are the primary attributes by which many consumers judge the value of biofuels. Biofuel-rich blends, such as E85 and B20, are much less common in the United States than are petroleum-rich blends, such as gasohol (E10). Consistent with economic theories of adoption, consumers who are generally unfamiliar with biofuels have been hesitant to use them, even where they are available. On a gallon of gasoline equivalent basis, biofuels have historically been more expensive than gasoline and diesel. Because of high prices, low availability, and lack of familiarity, there has been little consumer demand for biofuels for many years. Current use of ethanol in E10 blends does not require any explicit consumer choice, because E10 and conventional gasoline have similar attributes and are rarely, if ever, offered as alternatives. 

Availability of Biofuel Vehicles 

The long-term market potential for biofuels will also depend on the availability of light-duty vehicles capable of using rich biofuel blends. For ethanol demand to grow beyond the market for E10, fuel containing up to 85 percent ethanol must be marketed and sold. Although the incremental cost for vehicle manufacturers to make some models E85-capable at the factory is low (about $200 per vehicle), virtually all FFVs built since 1992 have been produced for the sole purpose of acquiring CAFE credits. About 5 million FFVs have been produced since 1992. There is also no regulatory requirement that FFVs actually use E85, and buyers often are unaware that they own FFVs. 

Currently, ethanol has higher value in the light-duty vehicle fuel market as a blending component in E10 than as dedicated E85 fuel. Consequently, the vast majority of the first 16 to 20 billion gallons of ethanol produced per year is projected to be used in E10. When the E10 market is nearly saturated, incremental ethanol production would presumably be consumed as E85, displacing gasoline. The issue is similar for biodiesel. For biodiesel to penetrate the light-duty vehicle fleet beyond the B10 or B5 blending levels, additional biofuel-capable vehicles must be produced and marketed to consumers. Higher consumer demand for biofuels—resulting from evolving market dynamics or government intervention— would encourage expanded production of biofuel-capable vehicles by auto manufacturers. 

Market Effects of Government Policy 

Federal and State government policy and regulation of biofuels will affect the development of the biofuels industry, both now and in the future. Support for biofuels has resulted in a number of Federal and State policies aimed at reducing their cost, increasing their availability, and ensuring continued market demand during periods of low petroleum prices. The RFS established by EPACT2005 guarantees a market of 7.5 billion gallons per year for ethanol by 2012, providing some long-term stability for the industry. In addition, the blender’s tax credits reduce the cost of biofuels, making them more competitive with petroleum fuels. Significant funding is also provided by the Federal Government for research, development, and commercialization of cellulosic ethanol technology. 

State support for biofuels varies, but many States have instituted RFSs, reduced fuel taxes, and provided grants and loans for distribution infrastructure. Hawaii, Iowa, Louisiana, Minnesota, Missouri, Montana, and Washington have enacted standards specifying that transportation fuels sold in the State contain a minimum percentage of either ethanol or biodiesel [160], and similar legislation has been proposed in California, Colorado, Idaho, Illinois, Indiana, Kansas, New Mexico, Pennsylvania, Virginia, and Wisconsin. 

Government support has fueled the rapid growth of the biofuel industry and may have reduced long-term risk for biofuel investments. Changes in laws and regulations can have large impacts on the sector. Preliminary discussions surrounding the 2007 Farm Bill indicate that the final version may contain significant provisions related to the role of energy crops in the agricultural sector and how CRP lands can be used [161]. The Federal and State RFS programs may be revised as more experience is gained in their implementation and to accommodate shifts in the political and economic environment. If R&D efforts on cellulosic ethanol significantly reduce the costs of biofuels, tax and regulatory policy may need to be changed to accommodate new market realities. 

Finally, Federal and State budgetary issues could affect gasoline taxes and the blender’s tax credit. At levels of 16 billion gallons of ethanol and 1 billion gallons of biodiesel, the loss of Federal revenue as a result of the blender’s tax credit would be roughly $8 billion for ethanol and $1 billion for biodiesel in nominal terms, as compared with a current total loss of about $2.4 billion. Increasing budgetary impacts may lead to future reconsideration of the subsidy levels.

Notes and Sources

Contact: Peter Gross
Phone: 202-586-8822
E-mail: peter.gross@eia.doe.gov