Economic Effects of Biofuel Promotion. An Assessment with a World Dynamic CGE Model J. Brüha & V. Pisa Czech National Bank and Faculty of Humanities Charles University in Prague October, 22 - 23, 2010 J. Brüha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 1 / 26 Introduction and Structure of the Presentation Structure of Presentation • Motivation • Description of the Core of the Model 0 The Bellman's Equation for Oil Producing Region and Solution • Data, Parametrization and Calibration • Preliminary Results - Simulation J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 2 / 26 Introduction and Structure of the Presentation Structure of Presentation • Motivation • Description of the Core of the Model 0 The Bellman's Equation for Oil Producing Region and Solution • Data, Parametrization and Calibration • Preliminary Results - Simulation J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 2 / 26 Introduction and Structure of the Presentation Structure of Presentation • Motivation • Description of the Core of the Model 0 The Bellman's Equation for Oil Producing Region and Solution • Data, Parametrization and Calibration • Preliminary Results - Simulation J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 2 / 26 Introduction and Structure of the Presentation Structure of Presentation • Motivation • Description of the Core of the Model 0 The Bellman's Equation for Oil Producing Region and Solution • Data, Parametrization and Calibration • Preliminary Results - Simulation J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 2 / 26 Introduction and Structure of the Presentation Structure of Presentation • Motivation • Description of the Core of the Model • The Bellman's Equation for Oil Producing Region and Solution • Data, Parametrization and Calibration • Preliminary Results - Simulation J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 2 / 26 Why Biofuels? Biofuels as Policy Issue the EU • Directive 2003/30/EC on the promotion of the use of biofuels or other renewable fuels for transport • Directive 2009/28/EC on the promotion of the use of energy from renewable sources • the aim is to substitute 10 % of traditional fossil fuels (gas oil, gasoline) by biofuels (Fatty Acid Methyl Esters - Biodiesel, Bioethanol, etc.) by the year 2020 the U.S. • American Energy Independence and Secuirity Act • The aim is to place 15 bn. gallons of biofuels on the market by the year 2015 and 36 bn. gallons by the year 2022 Czech Republic • Air Protection Act 86/2002 Coll. • The aim is to place annually 6 % of biodiesel and 4,1 % of bioethanol on the market J. Bruha & V. Pis (CNB & FHS UK) CGE - Biofuel Promotion Why Biofuels? Economic Questions Appeared in Connection with Biofuels Economically related issues • Effects on employment (positive or negative and in which sectors) • Effects on prices of motor fuels (decrease due to competition or increase due to more expensive biofuels) a Effects on consumers (end use prices) • Effects on regions (decreasing dependency on crude oil coming from politically volatile regions?) J. Brüha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 4 / 26 Why CGE Model? The specifics of Biofuel Production/Consumption Chain Specifics of Biofuel Chain a Production chain begins in agriculture (first generation biofuels, also second generation biofuels) • Land Competition in Agricultural Production • Among different biofuels - (eg. crop for biodiesel or bioethanol production ?) • Between different biofuels and food (eg. sugar cane for sugar or bioethanol ?) • Land Competition with other Agricultural Uses and Other Types of Land Area • Pastures • Forests » Manufactured in industry sector (competition between refineries and biofuel producers) • Biofuels as well as their feedstock are largely traded (agricultural products like rapeseed or corn, maize, sugar cane, etc.) J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 5 / 26 Description of the core of the model Regions Regions in the Model • the Czech Republic, • the rest of the EU-27, • the OPEC countries, • the rest of the OECD, • rest of the former USSR, • the rest of Asia, • the rest of Africa, • the rest of Latin America, • the rest of Europe. Regional Characteristics • Endowed with an arable land C • Populated by a representative agent • Agent consumes final good C,t, food An, public good G,t, and supplies an inelastic amount of labor /_,t J. Brüha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, Description of the core of the model Description • So is the expectation operator • (3 is the parameter of the intertemporal rate of substitution • subindex / refers to regions • the subindex t refers to time Social Planner Problem - objective function Objective Function oo t=0 J. Brüha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 7 / 26 Description of the core of the model Social Planner Problem - sectoral production functions Production function in the final-good sector __Yit = Y(Kit,(itLyt,Fit)_ Description • Y is the neoclassical production function, we assume the Cobb-Douglas form of this function • Lyjt is the labor used in that sector • Fjt is the fuel used in that sector • (jt is the labor augmented technological progress J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 8 / 26 Description of the core of the model Social Planner Problem - sectoral production functions Production function in the fuel producing sector _^ = f(oft,c£Bft,q7jt,4)_j Description • f is the production function of CES form • 0jt are conventional fossil fuels used for the production of fuel • Bjt are agricultural inputs • (ft is the technology progress • Tjt is a back-stop technology • (ft is the corresponding technological progress • Fft is the domestic production of fuels □ & - ■ ~m -O^O CGE - Biofuel Promotion October, 22 - 23, 2010 9 / 26 Description of the core of the model Social Planner Problem - sectoral production functions Agricultural production function _Aft + Bft=A(L%,Ch(ft) Description » Cj is the agricultural land in region / • \Jlt is labor employed in agriculture • (ft is the exogenous technological progress J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 10 / 26 Description of the core of the model Social Planner Problem - sectoral production functions Oil extraction production function _Oi = x{K°,L°,Oft)_ Description • % is the production function in oil extracting sector capturing that it is costly to extract the oil using capital and labor, for oil non-extracting country holds: Oft = 0 (and also Olt = 0) • K° is sector specific capital in oil extracting sector - this type of capital can not be used in final good sector • L° is labor employed in oil extracting sector • Oft is oil extraction in region J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 11 / 26 Description of the core of the model Social Planner Problem - Identities GDP Cit + Git + ht + 4>{hu Kit) + /,? + 4>°(l°t, K°t) + *{n) + Xit = Yh Description • Ijt are investments • Kn is the capital used in the final good sector • 4>{i,t, K^) is the investment adjustment function • l°t are investments used in the oil extracting sector » K°t is capital used in the oil extracting sector with • 4>° is the corresponding adjustment cost function (for oil non-producing regions l°t = K°t = 0) • Xn are net exports of the final good • x{Tit) is the cost of using the backstop technology • Yjt is the production of the final good ■r>°-lt) = PStUct+i [YKt+1 + 4) = af 1 ioooz + (l -ao) (cbMPo + (aw^ (4) ' • A(L%,£i,(?t) = £i(?t(L%r Boundedly Rational Agents - Adaptive Expectations J. Brüha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 20 / 26 The Description of the Model Calibration o The utility function (average shares of food in consumption) o Government utility function (national accounts GNT spending) o Production functions (cost structure in industries) o International trade in oil and agricultural products replicate the trade balances o [3 takes conventional value from literature (0.95) o Sample averages of last 5 years o Improving calibration - exogenous processes on history o Solution: first-order dynamic system with some unobserved variables J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 21 / 26 An Illustrative Simulation Agricultural Export J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 22 / 26 An Illustrative Simulation Agricultural Production J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 23 / 26 An Illustrative Simulation Agricultural Employment J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 24 / 26 An Illustrative Simulation Oil Imports J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 25 / 26 Conclusion Future Extensions • Competitive Economy for the Czech Republic • Parameter Checks and Possible Estimation Possible Applications • Assessments of Policy Impacts in Selected Regions • Dynamics of Selected Commodity Prices J. Bruha & V. Pisa (CNB & FHS UK) CGE - Biofuel Promotion October, 22 - 23, 2010 26 / 26