Fuel replacement search goes on

The largest market for biofuel is currently the US, which mainly uses corn-based ethanol, although Brazil is also a growing market with the use of sugar-based ethanol while Malaysia and Indonesia’s burgeoning biofuel industry utilises palm oil.

Sarbjit Nahal, head of thematic investment strategy at BofA Merrill Lynch Global Research, notes in a research report “Extreme Weather Primer”, that demand for biofuels is forecast to increase over the next several years.

He explains: “According to the USDA, a majority of the production and consumption of biofuels will be driven by the US, Brazil, EU, Argentina, Canada, China and Indonesia from 2013 to 2022. Over that time frame in the EU, biodiesel and ethanol production are projected to increase 45 and 60 per cent, respectively. In Brazil, ethanol production is forecasted to increase 90 per cent for domestic consumption. Biodiesel production in Argentina is forecasted to increase 80 per cent from 2013 to 2022 due to increasing domestic demand and export demand.”

James Govan, manager of the Baring Global Agriculture fund, notes: “The US is expected to use more than one-third of its corn crop in the production of corn-based ethanol. The US has legally mandated standards for how much corn needs to be blended in [with other petrol based gasoline] and they’ve got this thing called the ‘blend wall’. They can only blend a certain amount of ethanol in with the gasoline.”

According to the US Environmental Protection Agency (EPA), nearly all gasoline sold in the US is now ‘E10’, which is fuel with up to 10 per cent ethanol. There are concerns about biofuels with an ethanol content of more than 10 per cent on the basis it could damage older cars.

However, in November 2013, the EPA announced a consultation on changes to the renewable fuel standards, including the possibility of a reduction in ethanol production levels. It stated: “Production of renewable fuels has been growing rapidly in recent years. At the same time, advances in vehicle fuel economy and other economic factors have pushed gasoline consumption far lower than what was expected when Congress passed the Renewable Fuel Standard in 2007. As a result, we are now at the ‘E10 blend wall’, the point at which the E10 fuel pool is saturated with ethanol.

“If gasoline demand continues to decline, as currently forecast, continuing growth in the use of ethanol will require greater use of higher ethanol blends such as E15 and E85.”

Mr Govan notes the need for new pumps for E15 creates a logistical issue for a higher blend of biofuel, while there has been a slow-take up of the E15 already available.

He adds: “The ethanol industry in the US has been profitable, although it is a very volatile industry. Longer term, what it really hinges on is greater acceptance of E15 instead of E10.

“That is the uncertainty. I would think over the longer term the ethanol industry is likely to grow, but in the very short term this proposed cut in the mandate has been disappointing.”

However, Desmond Cheung, manager of the BlackRock World Agriculture fund, points out the US biofuel changes are only a piece of the whole biofuel debate.

Europe has mandated that member states must “achieve at least a 10 per cent share of renewable energy in the total gasoline and diesel consumed in transport by 2020”, with liquid biofuels expected to provide the main contribution to this reduction.

Mr Cheung adds: “In Asia, there is a lot of discussion about Malaysia and Indonesia and whether they should use more palm oil and turn it into biodiesel. A lot of focus is on what governments are doing, but it’s also a question of economics, whether or not the biofuel supply is abundant enough to make it competitive to fossil fuels, which will be a big question for the future.”

Nyree Stewart is acting features editor at Investment Adviser