(By Fiona Harvey, Kevin Morrison and Mark Mulligan) - High grain prices are threatening the nascent biofuels industry, raising input costs and making the fuel less economic compared with oil.

Agricultural commodity prices have reached long-term highs in recent days, based on forecasts of hot and dry weather conditions this year in the US which could result in lower grain yields. This comes after oil prices have fallen by a quarter from their record peaks last year.

Corn prices reached another 10-year high for the second successive day when it touched $4.31 a bushel, up five cents on the day. But the doubling of corn, a main feedstock for US ethanol producers, over the past year at a time when oil prices are at the same level they were 12 months ago has raised questions over the viability of the biofuels industry without heavy government support.

High grain prices create problems for biofuels companies which produce ethanol from wheat and barley. Other biofuels companies make biodiesel from oil-bearing crops such as soya, peanuts, palm oil and rapeseed. The prices for most of these commodities have also risen strongly, reflecting strong demand for these crops as food, and additional demand from the biofuels industry.

Christian Langaard, chairman of Euro-Latin Capital, which invests in biofuels projects, said: “This is causing problems for certain producers.”

Earlier this week, production problems were reported at a biofuels plant in Spain jointly owned by Abengoa and Ebro Puleva. The plant was reported to be running below capacity and a halt in production was under consideration. But Ebro Puleva said the plant was guaranteed feed stock into March, though it admitted that the high cereal prices were squeezing operating margins.

Sophie Justice, director and head of renewables at RBC Capital Markets, said that rising grain prices were one of the biggest issues for biofuels companies. She said: “There is a real risk [to these companies from the higher prices]. The more uncertainty in the feed stock prices, the more the economics [of biofuels] are challenged.”

She said it showed that the biofuels industry was still heavily dependent on government subsidies in most countries.

The biofuels industries in the US and Europe are cushioned against market prices by heavy government subsidies, which lessen the impact of higher grain prices. Ms Justice also said investors in the biofuels market were unlikely to be deterred by the rise in prices: “There is a genuine sense that the ultimate economics will work and there will be a way to make them work, for instance by an increased demand for biofuels.”

Mr Langaard agreed that investors were still “very interested” in the biofuels market, which has been spurred by the increasing emphasis on energy security in the US, Europe and east Asia. President George W Bush announced plans earlier this year to reduce petrol usage by 20 per cent within a decade, largely by the increased use of biofuels. He said in his state of the Union speech last month that the US ethanol and alternative fuel output was due to reach 35bn gallons a year by 2017. In Europe, the European Commission set a target of 10 per cent of road transport fuels to come from biofuels by 2020, because of concerns over climate change.

Merlin Hyman, director of the UK’s Environmental Industries Commission, a trade organisation for environmental companies, said concerns over higher food prices caused by farmers switching to biofuel production were being overdone. He said that if biofuels made up 10 per cent of transport fuels, there should be little problem in producing enough. He said: “I hope there will be enough feed stock to ensure that there is not too much conflict between food and fuel.”

Brazil is the world’s biggest producer of ethanol, and its industry will be unaffected by high grain prices because its producers use sugar cane rather than wheat. Converting sugar to ethanol is more efficient than using wheat, and Brazilian companies are widely acknowledged to be the world leaders in efficient techniques to convert sugar cane to fuel.

Concerns over biofuels supply have prompted the US to start discussions with Brazil over ways to create a global market for biofuels by promoting common standards, according to reports. Mr Bush will meet Brazil’s Luiz Inacio Lula da Silva in March. But the US has so far refused to budge from its tariff of 54 cents a gallon imposed on ethanol imports into the US.

Although biofuels have been presented as a way of reducing greenhouse gas emissions, because the plants from which they are derived absorb carbon dioxide from the air as they grow, many environmental groups have begun questioning policies to increase biofuels usage.

This is because some of the countries planning to produce more biofuels are destroying rainforest to make room for plantations to grow palm oil, sugar cane or other biofuel crops. Other experts have questioned the energy savings produced by using biofuels, which require energy input to convert them from plants to fuels, and in the form of fertiliser to grow the crops.

The Financial Times Limited 2007
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