Is biofuel a sustainable substitute for oil, and are investors ready for it?

This is the year biofuels become a fact of life—by law. From the beginning of April, under the Renewable Transport Fuels Obligation (RTFO), suppliers of petrol and diesel must ensure that 2.5 per cent of the total volume is derived from renewable energy sources. This means that we will be putting more agricultural crops into our fuel tanks—and quite possibly fewer into our mouths.

There was a time when biofuels were seen as a magic bullet: a self-replenishing way of reducing the greenhouse gases that our cars belch out. But their stock has fallen rapidly. A white paper published by Tim Yeo's Environmental Audit Committee in January concluded that greenhouse gas emissions could be more easily reduced by "planting forests and restoring habitats". Other critics claim some feedstocks (such as maize, the prime source of US ethanol) consume almost as much energy to produce as the final fuel provides. There are also concerns that farmers are switching from food to fuel crops in developing countries where starvation is already a problem. And there are worries that biofuel demand for feedstocks is pushing up food prices.

There are also concerns that the UK, a supposed sustainability champion, has such a central role in a supposedly unsustainable practice. The RTFO is a stick, introduced because the carrot—20p a litre off the excise tax since 2002—hasn't worked. With the major oil companies (who run most of the petrol stations) dragging their heels, national biofuel consumption is running at about one per cent of the total. Some of it is imported from Brazil and elsewhere.

The RTFO minimum rises to 3.75 per cent in 2009 and five per cent in 2010. But suppliers can wriggle out of it by paying 15p a litre for any shortfall—money that is then shared out among suppliers who have met the obligation. Or they can buy credits from these suppliers, much like emissions trading.

The government would like to raise the minimum bio-content above five per cent, when certain conditions are met. One is that the costs are acceptable. Another is that European fuel standards are changed—at the moment, drivers risk invalidating their vehicle warranties if they use more than five per cent biofuel. A third, and the most politically sensitive, is that concerns over the sustainability of biofuels can be allayed.

Biofuels come in two types. Bioethanol is a petrol additive or substitute and is made, much like whisky, from fermenting sugars. Possible feedstocks include sugar cane, maize, wheat and sugar beet. Biodiesel is made from vegetable oils: rapeseed oil, palm oil, soya, even used chip fat.

The RTFO has spurred interest in UK biofuel production, although this has waxed and waned almost as much as environmental approval.
"Eighteen months ago, as investment boomed in the US, the market here caught the bug," says Matt Williams, a biofuels expert in Ernst & Young's renewable energy team. "We saw a lot of investors, but only a few projects."

But as feedstock prices have continued to rise, investors have become more cautious. Despite this Williams says there are now more projects looking for money. "Interest will probably swing back in 2008, particularly if feedstock prices start to come down. If not, stronger regulatory incentives will be needed if the industry is going to boom," he says.

Most UK bioethanol will be made from wheat. Among those companies planning projects are Ensus (Teesside), Green Spirit Fuels (Somerset and Humberside) and Associated British Foods, BP and DuPont with a joint venture in Hull. British Sugar recently began production, using sugar beet at its Wissington factory. UK biodiesel production is more advanced and uses mainly rapeseed and palm oil, though Argent Energy converts tallow and used cooking oil at its Motherwell plant.

D1 Oils makes biodiesel at its plant in Middlesbrough and plans another plant on Merseyside. If all of these plans come to fruition—by no means guaranteed—the UK should be able to make enough biofuel to meet the RTFO's five per cent minimum. But it can't all be done from domestic feedstock, particularly biodiesel.

"If we retained the three million tonnes per year of wheat that we now export and processed it into bioethanol, we could meet about five per cent of petrol demand," says Jonathan Scurlock, chief adviser on renewable energy at the National Farmers' Union.

Right now, the UK doesn't grow enough vegetable oil crops to feed its biodiesel industry, and is importing palm oil. To address the sustainability issue, the government has imposed reporting requirements on fuel suppliers. They will have to fill in forms stating the origin of the biofuels, the savings in carbon emissions, and the sustainability of the crops. "The UK is at the forefront of setting higher standards, and if we mess it up we'll lose our influence worldwide," says Scurlock.

Some of the heat will go out of the food versus fuel debate once second-generation biofuels come on stream. Today's sources are divertible food crops. Tomorrow's will be inedible, woody, cellulosic crops that can only be used for energy and may grow on poorer land.

Environmentalists want a switch to second-generation fuels as soon as possible. Many suppliers say these are a decade away, and will depend for their success on a viable first-generation industry. "Venture capitalists won't invest in capital-intensive, second-generation biofuels until they have confidence in the supply chain, in the bankability of biofuels in general," says Scurlock.