The combination of drivers behind the expansion of the biofuel industry is leading to runaway growth for which related markets are unprepared.
First-generation biofuel industries are developing rapidly, spurred by supportive policy environments. These are based on a number of considerations:
Biofuels are renewable and produce cleaner-burning fuels than hydrocarbon-based fuels
Biofuels reduce dependence on imports of crude oil or refined products, either through import substitution or supply diversification. Biofuel plants also act as additions to refining capacity.
Biofuels provide possibilities for rural development and for delivering development funds in ways that circumvent traditional agricultural subsidies.
These drivers are medium-to-long term, providing a good background to support investment in the industry. Investors believe the policy environment will remain positive and that goals being set by consumer-nation governments are ambitious given existing capacity, indicating a highly positive supply-demand outlook.
Biofuels are seen as having potential for both domestic and export markets:
• United States. The Energy Policy Act of 2005 included a national Renewable Fuels Standard (RFS) intended to double use of biofuels by 2012. The target is 4.7 billion gallons of biofuels a year by 2007, rising to 7.5 billion by 2012. According to the U.S. Renewable Fuels Association, the 2007 target was exceeded in 2006 when a record 4.9 billion gallons of ethanol was produced. Plants under construction should add 6 billion gallons of new capacity by 2009, significantly exceeding current RFS targets years in advance.
Biofuels find significant bipartisan support in the United States and a number of supportive policy ideas are being floated in and around Congress. These include raising RFS standards significantly, implementing loan guarantees or tax breaks, or improving infrastructure for ethanol use. Senators have proposed mandates in these areas rather than softer supports. The focus on distribution infrastructure reflects a fear that production capacity will grow while demand is stunted by a lack of access, leading to an ethanol glut.
• EU. While production capacity has for the moment outstripped supply, demand is expected to rise strongly on the back of biofuel use mandates. The Council of Environment Ministers on Feb. 20 endorsed a binding minimum target of 10 percent biofuel use in overall EU transport petrol and diesel consumption by 2020. Caveats were included, meaning the target could be less than binding, and the recommendation has still to go before the European Council and European Parliament. Even so, the policy direction is clear: Targets for biofuel use are becoming more ambitious.
• Brazil. Brazil is the world’s second-largest producer of ethanol after the United States and the world’s largest exporter. Its ethanol program has been going for over 30 years and it has well-established infrastructure for flex-fuel vehicles. Nearly 80 percent of cars sold in Brazil in 2005 were flex-fuel. The nation is also beginning to develop its biodiesel industry, as diesel use makes up 54.5 percent of the country’s road-transport market. For both ethanol and biodiesel, Brazil sees large export potential and Brazilian agro-industry is experiencing an unprecedented investment boom. State-controlled oil company Petrobras is, in particular, eyeing the U.S. market and Japan, which is expected to require 6 million liters of ethanol a year by 2010 as it phases in the biofuel additive ETBE.
• Malaysia and Indonesia. Malaysia and Indonesia together account for 85 percent of global crude palm oil exports. Production in Indonesia, where land resources are greater and labor cheaper than in Malaysia, has tripled over the last decade, while output has doubled in Malaysia. By 2009, the two countries hope to supply 20 percent of European biofuel demand. At the same time, Indonesia hopes palm oil will replace about 10 percent of domestic oil consumption by 2010. Palm oil acreage is expected to reach 7.9 million hectares by 2010, up from 4 million in 2005. Malaysia had an estimated 4.2 million hectares of oil palm acreage in 2006. Both countries are pursuing higher crop yields and extraction rates, while also encouraging the domestic bio-refinery industry so they can export biodiesel rather than crude palm oil.
There is considerable debate as to whether biofuels are carbon-neutral, whether they are sustainable and whether they are energy efficient:
• Demand for feedstock. U.S. corn prices have increased and greater domestic demand has reduced exports, impacting world markets. In January, the U.S. Agricultural Department predicted corn prices would this year reach the highest level in a decade, while supply will fall to just three weeks’ use. The Washington-based Earth Policy Institute estimated in February that in 2008 the U.S. ethanol industry would require 139 million tons of corn — more than double the 60 million tons forecast by the USDA.
Vegetable oil prices have increased as a result of the use of rapeseed in Europe and palm oil in Asia for biofuel production. Bumper sugarcane crops in Brazil and India have balanced supply and demand this year, but last year sugar prices hit high levels as a result of biofuel production, forcing intervention by the Brazilian government in its domestic market.
Pressure on agricultural resources means that risks to the economics of biofuel production are twofold:
A drop in oil prices would make many biofuel operations uneconomic and government mandates would become dependent on increased financial support to be met.
Higher feedstock prices resulting from increased demand or bad harvests would impact on biofuel production economics from the other direction.
• Carbon neutrality. Meeting expanding biofuel and food-market demands from the same feedstocks implies a major expansion in land use for crop production. This in turn implies greater water, fertilizer (much made from natural gas) and machinery use in the agricultural sector. Where commercial plantations replace rainforest in Brazil and peat lands in Indonesia, they are by no means carbon-neutral. Preventing deforestation is increasingly seen as a means of combating climate change.
• Trade issues. While biofuels offer new industries for agricultural communities and producers, particularly in the developing world, there are as yet no international agreements on whether they are industrial or agricultural goods. The United States already levies a tariff on Brazilian ethanol imports, while subsidizing its own farmers to produce corn. Drivers supporting growth of domestic biofuel industries may well conflict with the development of an international market, from which developing-nation producers could benefit.
• Long-term risks. Longer-term, pressure on land use has an additional dimension. A key impact of global warming is expected to be loss of arable land and increased water scarcity. This raises the prospect of a need for greater land use — but falling availability — when food demand from countries such as India and China is rising. The combination could potentially result in higher famine risk, political instability and international competition for resources.
The first wave of biofuel industry expansion could quickly run into problems, potentially leading to a reversal in the current positive policy environment. Policymakers’ attention would be likely to turn to second-generation biofuels made from cellulosic materials and non-food crops such as jatropha and switchgrass that can be grown on marginal arable land. In addition, algae-based biofuel may also reduce pressure on traditional food feedstocks.
Oxford Analytica is an international consulting firm providing strategic analysis on world events for business and government leaders. See www.oxan.com.