Unfeasible biofuel initiative - Malaysiakini

In a few short years, Malaysia has seen its vision of sustainable development through biofuel production turn into a mirage.

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The government developed ambitious biofuel policies in 2005 when it appeared that the country’s key agricultural product, palm oil, could be profitably transformed into biodiesel. The policies aimed to expand the market for palm oil, improve energy security and create a new export industry.

Malaysia subsidises the end-user prices of petroleum transport fuels so, by replacing a proportion of petroleum diesel with biodiesel, the government hoped to reduce its subsidy burden.

Environmental considerations were a minor motivating factor, with the government seeking to improve ambient air quality and reduce emissions of greenhouse gases through increased biofuel use.

However, the very striving of governments worldwide to encourage the production and use of biofuels undermined the economic viability of the industry. In 2007, global production was approximately 70 million litres of biofuels, converting millions of tonnes of vegetable oils, tallow, grains and sugar cane to biofuels.

A sizeable portion of this production occurred in OECD countries, supported by government incentives that are estimated to have totalled over US$15 billion in 2007 alone. The result was a major surge in demand for agricultural commodities over the past two years, causing dramatic rises in prices, including for palm oil.

High feedstock prices put biofuels beyond the reach of any but the wealthiest nations that can afford to maintain subsidies.

Malaysian biofuel producers were not able to draw on significant domestic government support to maintain their operations.

To date, government support for the Malaysian biodiesel industry has been limited to RM60 million (US$16 million) in low-interest loans in 2004, and RM12 million (US$3.3 million) in federal grants for demonstration projects in 2006. Plans to mandate the replacement of five per cent of domestic diesel consumption with palm-based biofuel (B5) were never implemented.

Hoped-for jobs from the biofuels industry did not materialise and, instead, many biofuel facilities suspended operations in 2008, stranding public and private investments.

Worsen subsidy burden

While 92 biodiesel projects had been approved in Malaysia during 2006 and 2007, a survey of plants in September 2008 revealed that there were 14 functional biodiesel plants, only eight of which had produced biodiesel in 2008 (approximately 130 000 tonnes—less than ten percent of their potential production capacity).

The remainder had suspended operations due to high feedstock prices, and a further four had closed. Eight new biodiesel plants were under construction.

Assuming no further closures or cancellations, total production capacity is expected to reach approximately 2.7 million tonnes in 2009.

Biodiesel is estimated to cost around RM0.67 (US$0.20) per litre more to produce than petroleum diesel when palm oil is RM3000 per tonne and Malaysian Tapis crude petroleum oil is US$115 per barrel.

Replacing petroleum diesel with biodiesel would therefore worsen the government’s subsidy burden, rather than improve it. The Malaysian Government’s consumption subsidies for petroleum fuel have been estimated to total around RM25 billion (US$7.8 billion) in 2008 alone.

Replacing five per cent of petroleum diesel with biodiesel would add RM395 million (US$122 million) per year to this subsidy bill, at the above mentioned prices.

A B5 mandate would lock Malaysia into consuming around 500000 tonnes (approximately 560 million litres) of biodiesel per year, regardless of its cost relative to petroleum diesel. The implications could be expensive.

For example, if petroleum oil prices fell to US$75 per barrel while palm oil rose to RM5000 per tonne (only RM500 higher than prices in March 2008), the subsidy cost of supplying five per cent of Malaysia’s diesel from biodiesel would be around RM2.2 billion (US$675 million) per year.

Crude oil vs palm oil balance

A biofuel mandate would be a retrograde step for the Malaysian Government, which introduced measures in June 2008 to restructure the price subsidy for petroleum fuels. Fuel subsidies increase consumption, discourage more efficient use of resources and absorb national budgets that could be spent on social services (such as health and education).

By moving fuel prices closer towards the international market price, the government generated subsidy savings in the transport fuel and electricity sectors of RM14 billion (US$4.2 billion) in 2008 alone.

If palm oil is cheap relative to petroleum oil, replacing five per cent of Malaysia’s petroleum diesel with biodiesel could generate subsidy savings.

For example, if the palm oil price were to fall to pre-2006 prices of around RM1500 per tonne while petroleum oil prices shot up to US$175 per barrel, a B5 mandate would reduce government subsidies by around RM1400 billion (US$430 million).

Were such circumstances to arise, however, production and blending of biodiesel would be profitable, eliminating the need for government intervention.

The profitability of Malaysian biodiesel production is precarious, depending on volatile palm oil and petroleum prices, and decisions of policymakers both in Malaysia and overseas.

The vast majority of Malaysia’s current biodiesel production is exported, mostly to the EU and United States where domestic subsidies support biodiesel use (including imports).

Malaysian biodiesel is likely to be benefiting from a loophole in U.S. legislation that allows fuel blenders to claim a US$1 per gallon (US$0.26 per litre) subsidy for blending biodiesel (including imports), even if the product is then re-exported (usually to the EU, where the biodiesel can access additional consumption subsidies).

Pressure from the EU to close this loophole could prevent Malaysian (and other) biodiesel exporters from accessing the U.S. subsidies. In the longer term, sustainability standards could limit access into the EU of all but certified biofuels and feedstock.

Despite biodiesel being uneconomic, many countries have supported the development of a domestic biodiesel industry for social and environmental reasons.

There is no evidence to suggest a strong social or environmental rationale for promoting biofuels in Malaysia. While high commodity prices have delivered benefits to some, these have been more than offset economy-wide by rising food prices, which have hit the poor hardest.

Oxfam (2008) estimated that high food prices attributed to global biofuel production have caused 30 to 75 million people to fall into poverty and to jeopardise the livelihoods of 100 to 220 million people.

Forest clearing offsets benefits

The presumed environmental benefits of biodiesel—most notably in terms of reducing greenhouse gas emissions—have evaporated with improved understanding of the full lifecycle impacts of biofuel production.

Biodiesel is commonly considered to be "carbon neutral" because carbon released in burning the fuel is offset by growing the feedstock.

However, the conversion of forest to oil-palm plantations has been has been found to cause greenhouse gas releases that far outweigh any carbon emission reductions arising from the use of biofuels sourced from that land.

The expansion of the palm oil industry in Malaysia has been associated with deforestation, release of carbon from vegetation and soil, forest fires, soil erosion, water pollution and biodiversity loss.

Current domestic production of biodiesel in Malaysia is unlikely to be driving deforestation, due to low production levels.

However, the growing global demand for palm oil—largely due to increased demand for vegetable oils for biodiesel production—has contributed to a plantation expansion boom in Borneo, with associated deforestation and social conflicts.

The Government has said that no more forest reserves will be converted to oil-palm.

However, it is allowing land previously zoned for agriculture to be cleared, including rainforest.

Should the Malaysian Government institute its B5 mandate, 570 000 tonnes of palm oil would be required. This equates to approximately 130 000 hectares of land or three per cent of the current 4.2 million hectares currently under cultivation.

The majority of new Malaysian oil-palm developments are in the states of Sarawak and Sabah.

These state governments have a great deal of autonomy and it appears that, in some areas at least, environmental impact assessments are not being performed rigorously.

Many Malaysian firms are also operating in the Indonesian provinces of Kalimantan and Riau, which have high rates of conversion of forest to oil-palm, and less exacting governance structures.

These fundamental elements of biodiesel production are unlikely to change in the near term. In the meantime, measures to address sustainability issues will become increasingly important in order to supply environmentally-conscious markets.

Such measures might improve the environmental credentials of palm oil destined for OECD markets, but are likely to do little to avoid expansion of uncertified oil-palm and consequent deforestation.

As for the international export opportunities, prospects have diminished since the early euphoria. European Union and U.S. subsidy policies may currently be improving the viability of Malaysian biodiesel exports, but policy changes in the future may limit access for Malaysian biodiesel to U.S. and EU subsidies.

Refrain from intervening

In light of the limited economic, social and environmental benefits of promoting biodiesel in Malaysia, this report recommends that the government refrain from intervening in the market for biofuels, through such measures as offering direct price support or imposing mandatory blending.

The biofuel industry should be allowed to function in response to market signals - consistent with environmental and social standards - so that the industry establishes itself on a sustainable rather than a government-dependent basis.

The government’s current plan to move domestic retail fuel prices towards the world price is commendable, particularly as steps are also being envisaged to ensure that adequate safeguards are provided for the poor.

The government has correctly surmised that biodiesel can only, at most, complement other energy sources. It cannot significantly augment the nation’s energy supplies.

A B5 mandate would only lock in a new form of fuel subsidy that is delinked from market forces, thus creating new inefficiencies in the economy that would likely require painful reform in future years.

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GREGORE LOPEZ is a postgraduate student at the Crawford School of Economics and Government, Australian National University. The above is a summary of this biodiesel subsidy viability report