Big Money: Biodiesel’s flawed business model

-A +A

When an alternative energy giant like VeraSun Energy Corp, one of the biggest ethanol producers in the US, applied for bankruptcy protection, it is a clear indication that things are not right with the ethanol and biodiesel business model.

VeraSun, which took that step last November, accounts for 7% of the ethanol production capacity in the US. The company found itself in limbo as it had locked in corn prices at the peak only to find prices and demand declining as economic activities slowed.

In Malaysia, plans to build biodiesel plants were put on hold while those that are already up operate at a fraction of capacity. At the height of the hype, it was reported that more than 90 biodiesel licences have been approved. According to the Malaysian Palm Oil Board (MPOB), by the end of December 2008, only 14 plants had been established with a total capacity of 1.7 million tonnes per year.

Biodiesel plants in Malaysia use crude palm oil (CPO) as feedstock, since the oil is in ample supply. For this reason, CPO price latched onto crude oil price movements, creating a link between the two very different oils. Soaring crude oil prices supported the case for biodiesel as an alternative fuel and as crude oil rose, so did CPO as well as other “energy” crops such as corn and soya bean. But now, with crude oil back to the US$40 (RM148) a barrel level, biodiesel finds itself competing with lower crude oil prices, or rather lower diesel prices at the pump.

Based on back-of-envelope calculations, biodiesel production is no longer viable. At the current CPO price of RM2,000 per tonne and conversion cost of US$150 per tonne, each tonne of palm-based biodiesel costs RM2,550. According to the Feb 16 issue of World Biodiesel Price Report, palm oil methyl ester was priced at US$660 to US$670 per tonne (RM2,400 to RM2,445 based on RM3.65 per dollar). So, is there a case for biodiesel still?Kulim Bhd, which operates two biodiesel plants using CPO as feedstock, thinks there is. Its managing director Ahamad Mohamad believes biodiesel will continue to be important in the context of ensuring energy security and preserving the environment.

“If biodiesel is viewed as an alternative fuel, then the viability would depend on the spread between CPO and crude oil prices. However, if biodiesel is regarded as a green fuel and an important component in efforts to address climate change, then it changes the whole viability equation. Political or government support is necessary to ensure successful implementation of the biodiesel policy,” he adds.

When biodiesel producers seem to struggle both when CPO prices are high and low, government support is indeed critical in ensuring their survival. Lately, the government has stepped up efforts to support biodiesel producers with the B5 mandate, starting with government vehicles in February, to be followed by the industrial and transport sectors. Its price at the pump will be the same as diesel’s and any cost burden arising from price differences will be borne by the government.

Minister of Plantation Industries and Commodities, Datuk Seri Peter Chin Fah Kui, views alternative fuel production as the third arm of demand for CPO: the first being its use in food and second, in oleochemical industries. The third arm of demand is rising steadily as export figures from the MPOB show. In 2008, biodiesel production rose 32% to 171,700 tonnes while exports almost doubled with 182,108 tonnes compared to 95,013 in 2007. The US was the largest buyer, accounting for 39.2% of total biodiesel exports, followed by the EU with 38.6%.

But 171,700 tonnes is just 10% of the existing capacity of 1.7 million tonnes. As for exports to the US and Europe, Malaysia’s total export is just a drop in the ocean compared to their annual biofuel consumption. In 2007, the US’ fuel ethanol demand alone reached 5.4 billion gallons. Furthermore, Europe’s position on palm biodiesel is not quite crystal clear either.

“There has been no outright ban by the EU on the use of palm oil as a feedstock for biodiesel. But the precise position is unclear. This is unhelpful but a fact,” says Gary Mead, senior commodity analyst at UK-based VM Group, a commodities research consultancy. He explains that while the latest EU policy on biofuels is clear, the Renewable Energy Directive stipulating that 10% of its transport fuel should come from biofuels by 2020 does not say what form the biofuels should be in — whether ethanol, biodiesel or cellulosic ethanol.  

Meanwhile in Germany, the biggest biodiesel producer in the eurozone, the government is proposing changes to its biofuel programme, including disqualifying certain biofuels from being counted towards the biofuel mandates of the EU and denying the producers any tax incentives if the biofuels had been made with soya bean or palm oil unless the German government implements a sustainability criteria law for biofuels. Furthermore, it must be proven that the biofuels abide by these criteria. The draft legislation has been referred to the European Commission, which is currently considering the matter. The German parliament may vote on this proposed law next month and if passed, may make imports of palm oil into Germany for biodiesel more difficult, says Mead.

Nevertheless, he is optimistic that even if the vote goes through, palm oil will still be viable as a biodiesel feedstock but there are likely to be stiffer hurdles ahead in terms of the oil’s sustainability.

“The collapse of the price of crude oil has removed the incentive for private enterprise to step up production of biofuels but we see the price of crude oil rising much higher than today over the next three years, so the incentive to produce biofuels will at some point return,” says Mead in email responses to The Edge.

But while waiting for biodiesel to be commercially viable again, the government’s 5% mandate, is not expected to provide much of a boost to local biodiesel producers as the amount of biodiesel required only takes up 30% of existing production capacity. Furthermore, the minister has said the blend may vary should the additional cost to the government become too high. So, when CPO price goes up and biodiesel production is scaled down, biodiesel producers will find themselves back to  square one. Whichever way you look at it, prima facie, the biodiesel business model using food commodities as feedstock is a flawed one.This article appeared in The Edge Malaysia, Issue 744, March 2-8, 2009.