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10-06: Renewable Fuel and the Global Rebound Effect

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Evaluations of renewable fuel standards typically compute the reduction in global greenhouse gas emissions based on the amount of fossil fuel “displaced.” However they universally fail to provide any explanation of how displaced fuel stops the production of fossil fuel. In spite of this, they assume that every gallon displaced does, in fact, stop exactly one gallon of production.

In its 2010 analysis of the national Renewable Fuel Standard Program (RFS2), the Environmental Protection Agency (EPA) explains that this is not the case, but it continues to rely on this assumption nonetheless. If fact, to the extent displacement does stop production, it must do so by reducing the world oil price. But reducing this price will increase the demand for fossil fuel just as it decreases supply. This increase in demand is the global rebound effect, and it partly cancels the climate benefits of producing renewable fuels. 

The main difficulty with estimating this effect lies in estimating OPEC’s response to a decline in the price of oil. To make use of a broad spectrum of expert opinion on this question, the sensitivity of the world oil price to a change in supply is estimated from the results of several well respected models. The estimated sensitivities are then combined with the EPA’s estimated world demand elasticity of oil. The resulting estimates of the global rebound effect range from 29 percent to 70 percent, with the estimate based on EPA’s values coming in at 32 percent. This value implies that a tradition estimate that ethanol will reduce GHG emissions by 22 percent should be corrected to indicate an increase of 10 percent in GHG emissions.