Currently, the biodiesel market is not truly competitive in a free market, but rather continues to be propped up by subsidies (most companies with major biodiesel production capacities showed negative operating profits for 2011, based on data from Google Finance). While subsidies in the form of per gallon tax credits for biodiesel producers expired at the end of 2011, there remain numerous avenues through which federal and state governments subsidize biodiesel and other biofuel production, including through agricultural feedstock subsidies.
Source: Koplow (2006)
Additionally, states in the U.S. have increasingly supported the biodiesel industry through setting minimum standards for proportions of biodiesel required in diesel fuel, as part of pushes toward energy independence, addressing rising fuel costs, and decreasing the environmental detriments of reliance on fossil fuels.
Excessive subsidies are likely to lead to reduced competition and less innovation (see Aghion et.al, 2005 for the theory of a U-shaped relation between competition and innovation). Numerous analyses of U.S. biofuel subsidies have suggested that they are not a cost-efficient destination for subsidies if the government is truly interested in energy independence and addressing global warming and other environmental challenges (see Limitations), compared to other alternative fuel sources or energy efficiency projects. Political issues such as rising gas prices, foreign policy, and the influence of agricultural sector interest groups are major determining factors for public support for first generation biofuels and are most likely biasing subsidies and R&D funding away from more nascent biofuel technologies which offer greater future promise but fewer immediate benefits in these political areas.
On the other hand, if biodiesel industry R&D has the potential to offer important positive technology spillovers for other industries, such as agricultural production and biotechnology more broadly, then a case could be made that government support corrects for market failures due to positive technological externalities. However, as discussed here, recent biodiesel industry innovation has tended to take the form of small-scale quality ladder improvements with a relatively high degree of appropriability. Small, industry-specific innovations , such as improving biodiesel refinery procedures, are less likely to produce either drastic new ideas or innovations that offer large spillover effects, both of which would suggest that the ideal industry structure for biodiesel is a competitive one and that it makes less sense for the government to invest in biodiesel production R&D than in agricultural production R&D, which would offer greater spillover likelihood for a variety of industries, or in advanced second and third generation biofuel technologies, with are still in development stages but could significantly revolutionize fuel production (D’Aspremont and Jacquemin 1988, Gelabert et al. 2009).
Aghion, Philippe; Bloom, Nick; Blundell, Richard; Griffith, Rachel; and Peter Howitt. (2005). “Competition and Innovation: An Inverted-U Relationship.” The Quarterly Journal of Economics 120,2: 701-728.
D’Aspremont, Claude and Alexis Jacquemin. (1988). “Cooperative and Noncooperative R&D in Duopoly with Spillovers.” The American Economic Review 78,5: 1133-1137.
Gelabert, Liliana; Fosfuri, Andrea; and Josep A. Tribo. (2009). “Does the Effect of Public Support for R&D Depend on the Degree of Appropriability?” The Journal of Industrial Economics 57,4: 736-767.
Koplow, Doug. (2006). “Biofuels – At what cost?: Government support for ethanol and biodiesel in the United States.” The Global Subsidies Initiative, International Institute for Sustainable Development.