It occurs to me that there is a missing piece to the talk about what a future with biofuels would look like. In particular, if carbon-based pollution has a significant social cost – and indeed we discuss a pricing for carbon in cap-and-trade policies – do we need to more clearly regulate this issue in the future?

Biofuels, when successful, might close the gap on overall CO2 emissions. But they still do emit CO2 (and other stuff) when combusted in our cars; it’s still a local pollutant in cities where it is consumed.

Today, ethanol is grown in Iowa and shipped to, say, Illinois for refining then sold in Minneapolis or Chicago. The CO2 was removed from the atmosphere in Iowa, but re-emitted as a pollutant in Minnesota (who suffers all of the local effects).

Does Iowa “owe” Minneapolis or Chicago something for exporting its CO2 as a pollutant? Did these cities assume this risk when they decided to sell Iowa-based ethanol? How would anyone know where the ethanol came from to collect on such a debt? Should Chicago or Minneapolis only allow ethanol that was made nearby?

This is a strange sort of thinking on my part. I don’t know the answer to it and, frankly, I would hate to see what type of policy these politicians would mutate from this. What this scenario illustrates is that there are still issues to be solved regarding how we balance our global environmental opportunities with our local environmental responsibilities. While we all want to be carbon neutral (or, given the name of this blog, carbon-free), there’s always more to consider than just the technological capability.

It’s done. It’s signed. The 2007 Energy Bill (officially as HR 6 The Energy Independence and Security Act of 2007) has several far-reaching policies. I wanted to take a look at two important ones: the expanded renewable fuels standard (RFS) and the increased CAFE standard.

Expanded RFS
The Expanded RFS standard, if achieved, could go a long way to reducing our petroleum-based fuel demand. I ran a few numbers using the schedule included in the bill (and the Renewable Fuel Association website) to see what type of investment would be required to meet the volume capacity requirements. If we assume that capital costs for a corn ethanol facility are around $1.50/gallon of annual capacity and that advanced ethanol facility run around $2.50/gallon, we get the following investment amounts:

This is doable, from a magnitude standpoint. It would require a lot of renewed enthusiasm around the industry. It’s important to note, not surprisingly, are that corn ethanol has a limited future and that the future of the industry requires advancements in cellulosic ethanol…right now.

Even more than a technological breakthrough being needed, the innovation needs to improve the fundamental economics around ethanol. It’s clear from the financial statements of current corn ethanol producers that current market economics are not adequate for generating enough capital to reinvest in this much capacity.

For example, VeraSun generated $300 Million in cash in 2006, but the vast majority ($233 Million) came from stock issuance. Pacific Ethanol did about the same in 2006 – $230 Million from stock issuances. But you can’t run a business indefinitely by doing stock issuances. You have to eventually start generating cash from normal operations and investments (For an extreme comparison, Microsoft generated about $23.8 Billion from normal operations and investments in 2006 and spent most of it on stock buybacks and dividends – both good for shareholders).

The exciting thing is that there are a lot of new companies out there with some great opportunities for changing biofuel economics.

CAFE Standards
CAFE standards are slated to go to 35 mpg by 2020. I ran some numbers (Download my Energy Bill Analysis spreadsheet – XLS) on what the impact of the CAFE standard would be. The impact would be dramatic. The results are a bit tricky. The tricky part comes in the assumption of the changes in the miles driven. If its mild (say, 0.5%/year), then the impact would be around 307 Million Gallons (or about a 15% reduction).

Which is more impactful?
I would say the RFS standard will ultimately have a greater impact in the long-term. 36 Billion gallons of capacity would supplant 25% of today’s demand. As the CAFE standards increase, then the RFS might supplant more than 30% of the nation’s oil demand. That seems a little better than a net 15% improvement on oil consumption over a 15 year period.

Challenges ahead
While this energy bill is very encouraging, it’s still more well-meaning than anything else. The biofuels industries have a lot of roadblocks ahead of it. Meeting these capacity targets for ethanol will be a challenge. Designing cars with ultra high efficiencies will also prove challenging (although I think we’re on our way). But it seems to me that challenges like these are what we do best.

Happy Holidays.