Gal Hochman, Deepak Rajagopal, and David Zilberman
University of California-Berkeley

To quantify the effect of biofuel on global oil markets, we extend the optimal export tax model to the global fuel market (henceforth, denoted as the Cartel-of-Nations model), recognizing that crude oil extraction and production are concentrated in a few countries (namely, the Organization of the Petroleum Exporting Countries), and that there is a wedge between fuel prices in oilexporting and oil-importing countries. We calibrate the Cartel-of- Nations model to include biofuel using 2007 data. We show that the introduction of biofuel reduces international fuel prices by between 1.07 and 1.10%, as well as reduces the quantity of fossil fuel (i.e., gasoline and diesel) consumed by oil-importing countries by between 0.3% and 0.7%. The global amount of fuel consumed (gasoline, diesel, and biofuels), however, increases by 1.5-1.6%. This outcome suggests that although the introduction of biofuels changes the composition of the fuel consumed (resulting in less carbon emissions per gallon of fuel consumed), it also increases global fuel consumption (resulting in more carbon emissions). The magnitude of these two opposing forces, and therefore the environmental benefits from biofuels, depends on the supply elasticity of fossil fuel and on the pollution intensity of the biofuel feedstock used. Finally, the introduction of biofuels causes welfare in oil-exporting countries to decline by 1.05-1.76%, but it causes welfare in oil-importing countries to increase by 2.92-4.10%.

Key words: Biofuel, ethanol, biodiesel, gasoline, diesel, crude oil, export tax, fuel prices, OPEC.