Taking an option on the future: Subsidizing biofuels for energy security or reducing global warming

This paper examines the biofuels industry from a policy and international trade perspective. Across the globe there are two main public policy objectives driving the development of biofuels industries—improving energy security and reducing global warming. The US and Canadian governments have respectively fostered biofuels industries for these reasons. As biofuels industries will not be financially viable without government support in the foreseeable future, government policies can be interpreted as taking options on the future. A theoretical model is developed using option value theory to determine whether the same governmental policy (subsidization) can lead to different levels of optimal subsidies in each country, where the subsidy policy is driven by two distinct motivating factors. If the reason subsidy levels differ is structural, the likelihood of a trade dispute arising increases.

► Biofuels subsidies represent governments taking an option on the existence of alternative fuels industries in the future. ► The motivations for subsidizing biofuels include energy security and reducing global warming and vary among governments. ► Differing motivations lead to optimal subsidies of different sizes. ► Permanent difference in subsidies can lead to international trade disputes.