Note: this article first appeared in Renewable Energy Focus September/October 2012. Click here for a free signup.
The outlook for the European ethanol sector has improved dramatically in 2012. The expiry of the blending credit in the US has meant that EU ethanol is now on a more level playing field with US ethanol while the recent adjustment to the E90 loophole has deterred low tariff imports. In addition the rally in US corn prices has further reduced the financial viability of US ethanol imports into the EU. However, despite improved conditions a number of significant issues remain.
Demand for European ethanol is stagnant, with limited E10 (fuel mix with 10% ethanol, 90% gasoline) uptake from the current E5, and diesel winning a greater share of transport fuel demand. The potential start-up of two huge plants in the UK, and the increased capacity that would bring, continues to cause concern to existing suppliers while, over the longer term, uncertainty over the 2020 targets laid out in the EU's Renewable Energy Directive (RED) and the Fuel Quality Directive (FQD) is hindering growth in the market. So how can this be overcome and what are the prospects for the future?
The impact of imports
Since the inception of the European market, domestic producers have struggled to compete with imported ethanol. Cheaper volumes of, first Brazilian ethanol, and secondly US product, have depressed margins and displaced market share, resulting in underutilisation of capacity. This has been despite what, on the surface, would appear to be very protective import tariffs.
A tariff of €192/cbm for un-denatured ethanol has been imposed (around 30% of the current market price) in around 75% of the European market, which includes Germany, France, Spain and parts of Sweden. A lesser tariff of €102/cbm (cubic meter) is charged in the remainder of Europe, including the UK and Netherlands.
Between 2005 and 2007, ethanol imports amounted to around 50% of production as supply lagged demand. However, a large expansion in EU capacity was underway, with much of this coming online in 2008 and 2009, which could have seen the EU become self sufficient. This was not to be the case however.
In the middle of 2008, imported ethanol began to appear in the UK, blended with around 10% gasoline. This allowed it to be classified as a chemical product as opposed to a fuel product, which qualifies it for a lower 6.5% duty (approximately €35/cbm), rather than the biofuel specific €102 duty.
As this loophole began to be increasingly exploited, a large flow of Brazilian ethanol started to move to Europe. In 2008, Brazilian exports to Europe rose 50% to 1.5bn litres. In 2009, as sugar prices rose, and production shifted from ethanol to sugar, Brazilian ethanol exports to Europe fell to around 1bn litres enabling the US to become a source of supply for the European market.
As the majority of the US ethanol was being blended with gasoline, in order to be able to meet the EU's lower import duty, this meant it was also able to benefit from a US domestic tax credit: the ¢45/gallon Volumetric Ethanol Excise Tax Credit (VEETC). As a result, US export volumes grew from around 400,000cbm in 2010 to in excess of 1bn litres last year, overtaking Brazil as the EU's primary supply source.
This had a depressive impact on the EU market as marginal demand for European production had to be discounted heavily to compete with US ethanol arrivals that were subsidised by the blending credit. As a result plants were shuttered while others have had to operate significantly below nameplate capacity.
The landscape for Europe's ethanol producers has since changed. At the end of 2011 the expiry of the VEETC brought the end of the ¢45/gallon blending credit in the US while, following heavy lobbying from European producer associations, the loophole which had allowed high ethanol blends with gasoline to be imported at a lower tariff rate was adjusted. This adjustment has raised the minimum gasoline blend from 10% to 30%.
The higher gasoline content has, so far, deterred further shipments of ethanol blended with gasoline, compelling imports into Europe to compete with domestic ethanol under standard import duties. Furthermore, the EU Commission is now investigating whether anti-dumping measures should be considered against the large volumes of US ethanol that were imported into the EU under the VEETC scheme.
Growth in Demand
Since 2005, when the first indicative target of 2% use of biofuels (EC Directive 93/2003) was implemented, European fuel ethanol demand has grown by over 500%. Demand grew through this period as member states, particularly Germany, Netherlands, Spain and the UK, aggressively raised mandates, while in other countries, such as France and Sweden, financial incentives were provided. At times during this period, ethanol was priced advantageously against gasoline, which encouraged discretionary use. As a result today, ethanol is in use at a 5% blend in most countries, and at higher levels, where ETBE is in use, and in some countries, where blends up to 10% are allowed.
However, today, demand stagnation appears to be on the horizon. Blending limits have been reached in most countries and very few countries to date have allowed E10 fuel to be sold. In those that have, uptake has been slow. Germany is a prime example, as motorists have been scared by supposed risk to their vehicles of running on E10 as opposed to E5, exacerbated by negative press coverage. Consequently, the consumption of E10 fuel is perhaps only 15–20% to total gasoline use, despite major discounts at the pump.
Whilst the EU, at least in the short-medium term, faces blend wall issues, this is not the only factor hindering demand. Gasoline demand has been falling at the expense of diesel for some time. The result is that the potential market for ethanol is shrinking.
In addition, the weak state of the Eurozone economies is also having a detrimental impact on gasoline usage. The impact of this is most acute in southern Europe: For example, gasoline demand in Italy in April 2012 fell by 16% y-o-y and in Spain by 13% y-o-y. Due to gasoline's falling market share the greatest prospects for ethanol demand growth in Europe will have to be through the use of higher blends.
This will have to arise from the implementation of the amended EU Fuel Quality Directive at a national level, which will adjust gasoline specifications to allow for a blend as high as 10%. But perhaps most importantly, the motorist has to be encouraged to adopt higher blends and must be assured that E10 presents no undue risks and is ideally seen as an improved fuel.
With EU member states required to incorporate 10% biofuels (energy basis) in all transport fuel by 2020, and required to reduce greenhouse gas emissions by 60% as well, even a full scale adoption of E10 will be insufficient to breach this hurdle. Rapid progress consequently needs to be achieved in the near future, otherwise the longer term aims of the EU's Renewable Energy Directive could be called into doubt.
Part 2 out soon.
About: Toby Cohen is a Director at global commodity house Czarnikow Group.