Until December 31, 2009, biodiesel makers enjoyed a tax credit of $1/gallon on alternative diesel fuel made either from feedstock such as soybeans or camellina or from waste such as yellow grease and animal fats. The credit for biodiesel fuel was approved by Congress for a two-year period beginning in 2004 and extended twice before being allowed to expire last week.

According to a report commissioned by the National Biodiesel Board, demand for biodiesel fuel will drop to 475 million gallons in 2009 from nearly 700 million gallons sold in 2008. The blame is placed squarely on the weak economy, which has decreased demand for diesel fuel generally. The biodiesel industry reportedly has production capacity of 2.7 billion gallons, so utilization is a mere 15% of capacity.

Because the credit is claimed at the time that the biodiesel is blended with petroleum diesel, the cost to consumers is not affected by the credit. The industry claims that the credit is necessary because the cost of producing biodiesel is higher than the cost of producing petroleum diesel. Soybean-based biodiesel costs about $3/gallon to produce, compared with petroleum-based diesel fuel which costs about $1.80/gallon.

Without the tax credit, diesel fuel marketers are unlikely to pay $3/gallon, instead offering to buy biodiesel at a price point equivalent to petroleum diesel. That is not enough for the industry to survive.

Pure biodiesel (B100) cuts emissions of carbon monoxide and particulate matter by about 50% compared with petroleum-based diesel fuel, and pure biodiesel burns with no sulfur emissions. The more typical 20% blend (B20) reduces emissions of carbon monoxide and particulates by about 12%, and sulfur by 20%.

Biodiesel would seem to be one of the industries that the Obama administration would support both because of its positive impact on the environment and its employment of about 23,000 people. The U.S. House of Representatives has voted to extend the credit, but the Senate has not yet taken any action. If the credit is extended, it will almost certainly be retro-active.

This story might sound reminiscent of the early stages of ethanol development. In the case of ethanol, even the federal subsidies and tax on imported ethanol could not support the high valuations on publicly-traded companies like VeraSun. That is likely to be the case again with biodiesel.

In the short-term, what happens with the biodiesel tax credit will have essentially no effect on diesel fuel prices for consumers. The relatively miniscule amounts of biodiesel have not caused any heartburn to the petroleum industry.

Overall, the economic impact on the U.S. if the biodiesel industry should disappear is not much. Like ethanol, making biodiesel is a relatively ancient technology and the fuel will never make a big dent in the fuel market. Its biggest impact will be made as a transition fuel to the development of cellulosic ethanol and other fuels based on biomass.

Unfortunately, every substitute for petroleum faces its own difficulties, not the least of which is scale. Ultimately, that is the problem for all biofuels.

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