With a debate over the efficacy of the U.S.’ Renewable Fuel Standard (RFS) reopened on Capitol Hill in Washington and policymakers in Brussels wrestling with conflicting reports about whether biofuels impact the environment and global food prices, it’s just another day in the in the office for the global biofuels industry.  While the questions remain the same, the temperature of the debate feels different this time around.

Last year, severe drought prompted the UN to urge U.S. policymakers to scale back or waive mandated volumes of corn starch ethanol production.  In January, a U.S. federal appeals court ruled in favor of the American Petroleum Institute (API), arguing that the Environmental Protection Agency (EPA) could not require refiners to buy credits for cellulosic fuel since there has yet to be any gallons produced commercially and at scale.

Meanwhile, across the pond, European policymakers are struggling to align alternative fuel ambitions with strict sustainability standards.  Progress has been clouded by recent reports complicating an already contentious debate over the land use impacts of increased biofuels production.  Clarity on the issue appears increasingly elusive.

These events have cast considerable doubt on the future of biofuels production in the United States and the EU, the first and third largest markets for biofuels respectively.  Current production offsets just 4% to 5% of petroleum consumption despite outsized ambitions from end-users like commercial airlines, defense, and ground transportation.  The mandates have been likened to filling a swimming pool with a thimble.

Shifting Gears

At the core of biofuel ambitions over the next decade is the commercialization of a host of conversion technologies targeting everything from agricultural residues to algae.  While conventional biofuels like ethanol and biodiesel derived from commodity crops are widely commercialized, advanced biofuels are still clawing their way toward commercial relevance.

First-of-kind biorefineries have come online in the past year with dozens more currently under construction, but the process has been slow, expensive, and arduous.  Navigant Research’s recently published study forecasts that just 9 billion gallons of advanced biofuel will be produced globally by 2020, a far cry from the lofty targets set by current mandates.

If the climate of uncertainty flowing from developments in Washington and Brussels persists, a mass exodus among advanced biofuel interests away from fuels production and toward bio-based products can be expected.  This migration is already several years in the making, but up to this point, most stakeholders have been content to hedge their bets in multiple markets.

Currently, the bio-based products market offers shorter runways to revenue than the fuels market.   In the low-margin, high-volume business of fuel production, profitability is predicated on economies of scale, which in many cases, are still a decade away for market interests.

By comparison, the bio-products market offers lucrative interests in high-margin, low-volume markets like food, feed, pharmaceuticals, chemicals, polymers, and paper.  Algae players are a key constituent in this group and are chasing high-value omega-3 fatty acid production.  Selling north of $2,000 a ton, omega-3s are a popular nutritional supplement, made more so by the increasing cost of seafood products due to overfishing.  By comparison, biofuels generate anywhere from $200 to $500 per ton.

The consequence of all of this is that advanced biofuels production at scale (for the sake of argument, greater than 7.5 billion gallons annually, or 1% of global petroleum fuel consumption) remains perpetually stuck on the horizon.  This will likely force policymakers to dial back biofuel ambitions to assuage public outcry for support of “snake oil.”  With Washington and Brussels jumping headfirst back into the debate, one wonders whether the biofuels industry has already reached this point.  Nevertheless, bio-based products and materials could provide a key stepping stone to advanced biofuels production profitability at scale.

A series of recent policy-related developments within the biofuels industry may have set the stage for what could prove to be a significant shift in biofuel geopolitics over the next decade. 

To recap: the European Court of Justice (ECJ) affirmed an earlier ruling that held the imposition of carbon taxes on flights touching down or taking off on EU soil did not infringe international law or the Open Skies Agreement; a U.S. District Court ruled that California’s Low Carbon Fuel Standard (LCFS) violates the U.S. Constitution; and the long-standing U.S. ethanol producer credit (aka “VEETC”) slipped quietly into the history books.   

Where do these developments leave the industry? 

While the inclusion of airline emissions in the EU’s ETS indicates that the buzz around aviation biofuels won’t fade anytime soon, the threat of costly trade wars by the United States and China in response to the ruling could put a crimp on the expansion of international biofuel trade flows. 

Meanwhile, just as the expiration of VEETC eliminates an estimated $6 billion worth of annual subsidies to the ethanol industry, the lucrative California fuel market is (at least for now) once again open for Midwest ethanol producers, and likely at the expense of Brazilian ethanol (more on this below).

On the whole, the decisions are generally good for advanced biofuels and corn-based ethanol alike. 

Aviation Biofuels Lack Production Volumes, Not Willing Buyers

In the case of advanced biofuels, the decision to uphold the carbon fee suggests that international carriers will not escape the added costs associated with doing business in Europe, adding further incentive to integrate carbon-cutting technologies.  As I discussed in an earlier blog, the combination of impending offset purchases and high oil prices appears to be forcing the aviation industry’s hand when it comes to fossil fuel alternatives, which has been signaling strong demand for sustainable advanced biofuels in recent years (note that first-generation biofuels lack the performance characteristics necessary to power commercial and military aircraft).

Although expected, the ruling is generally good news for energy feedstock producers looking to commercialize next generation feedstocks like camelina, jatropha, switchgrass, and algae, and seeking reliable markets and off-take contracts to offset the risk associated with growing relatively unknown crops.     

But the advanced biofuels story is not about lack of demand, which suggests that the ECJ decision may actually not have much impact at all.  In the case of the aviation industry, rising oil prices mean that demand for biofuel alternatives is deep, durable, and widespread.  Even without the EU tax, assuming adequate supply, price parity with petroleum-based fuels, and sufficient distribution logistics, aviation fuel buyers would be clamoring to lock-up every last drop of advanced biofuels production.

Meanwhile, with the threat of trade wars from the United States and China among others, costly tariffs and other punitive measures could actually stifle biofuels development, an unintended consequence of the aviation tax.      

Corn-based Ethanol Gets a Boost

Over on the other side of the pond, Judge Lawrence J. O’Neill’s December 29 decision declaring California’s carbon fuel standard unconstitutional represents a significant victory for Midwest corn ethanol producers (see my 2010 article on the LCFS and Green Federalism for more on the legal issues).  The California Air Resources Board’s (CARB) policy, introduced in 2007, aims for a reduction in the “life-cycle carbon intensity” of fuels consumed in the state by 10 percent over the next decade.  Due to corn ethanol’s inherent inefficiencies, the policy excludes most of the corn-ethanol produced in the United States from one of the world’s largest fuel markets. 

Implementation of the policy had led to the peculiar situation where Midwest ethanol producers were shipping their offending product 6,000 miles to Brazil to make up for a shortfall in sugarcane ethanol production.  Midwest corn’s exclusion from California, coupled with a national blending wall policy, put a serious constraint on U.S. producers’ scale-up ambitions.  The ruling may put corn ethanol back in the domestic driver’s seat, at least for now.      

Looking Beyond 2012

As discussed in Pike Research’s report, Biofuels Markets and Technologies, we expect the production of conventional biofuels – namely corn- and sugarcane-based ethanol – to increase steadily over the next decade as demand for alternatives to petroleum-based fuel outstrips advanced biofuels production volumes.  The corn-based ethanol industry appears to have established viability, and even without the VEETC, we foresee an increase in production as access to markets like California and the likely raising of U.S. blend walls (e.g. implementation of E15 or expansion of E85) opens up new opportunities for producers. 

The key question raised by these decisions: where will the production go over the next decade?  As corn-based ethanol ventures beyond VEETC, the industry will need to fight for market access at home and abroad despite this most recent victory.  Meanwhile, the EU may be positioning itself as the primary market for advanced biofuels at the expense of U.S. and China.