The effect of biofuel on the international oil market

This paper derives a method to quantify the short- to medium-run impact of biofuel on fuelmarkets, assuming that these markets are dominated by cartel of oil-rich countries, and that pricesin these countries are set to maximize the sum of domestic consumer and producer surplus, leadingto a wedge between domestic and international fuel prices. We model this behavior by applyingthe optimal export tax model (henceforth, the cartel-of-nations model) to the fuel markets. Usingdata from 2007 to calibrate the model, we show that the introduction of biofuels lowered globalgasoline and diesel consumption and international fuel prices by about 1% and 2%, respectively.We identify large differences between the effects of introducing biofuels using the cartel-of-nationsmodel, in contrast to the competitive or the standard cartel model (henceforth, the cartel-of-firms model). We illustrate that assessing the effect of biofuels assuming competitive fuel marketsoverestimates the reduction in fuel price, and underestimates the reduction of gasoline and dieselconsumption, and therefore impact of biofuels on greenhouse gas emissions, when compared tothe effect under a cartel-of-nations model. Similar conclusions are derived with respect to cartel-of-firms model. Finally, we illustrate that a 20% increase in fuel demand more than doubles theimpact of biofuels on fuel markets, compared to 2007.