Subsidization of the Biofuel Industry: Security vs. Clean Air?

Agriculture plays an important role both in reducing Greenhouse Gas Emissions (GHG) and dependence on imported oil from economically and politically volatile areas. Certain crops can be used as inputs for the production of alternative fuels. In addition to these two benefits, the development of biofuel industry has other secondary advantages including rural development. As the current price of biofuel is considerably greater than the price of fossil fuel alternatives, the governments around the world are heavily subsidizing the development of this industry. This paper focuses on the growth of biofuel industry in Canada and US. We develop a theoretical model to examine whether or not the same governmental policy (subsidization) yields different results i.e. a different level of optimal subsidies under different current objectives. We consider that subsidizing the development of the biofuel industry in the present is equivalent to buying an option on its use for future goals energy security or reduced GHG emissions- so our research uses option value theory to assess these alternatives. The theoretical model yields an optimal subsidy option function for each of the two countries. Furthermore, under the scenario of obtaining different optimal levels of subsidies in the two countries, trade disputes can arise. A numerical simulation method is proposed to quantify the optimal level of subsidy option for each country.