The Covid-19 pandemic has sent a shockwave through the global oil industry, which, along with the subsequent oil prices shock, has created a unique set of challenges for the biofuels sector.
BloombergNEF has identified three ways in which Covid-19 and the oil price shock are disrupting biofuels:
- The immediate impact of Covid-19 is demand destruction. Lockdown measures have caused a contraction in global demand for transport fuels, into which biofuels are typically blended. Furthermore, low oil prices mean biofuels are less competitive, and could struggle to maintain market share.
- Cheap oil and supply chain disruptions put pressure on margins for producers, which could lead to consolidation in key markets.
- Greater policy uncertainty as lower oil prices increase the need for policy support to sustain the growth of the biofuels industry. Covid-19 has already caused several delays to planned policy rollouts, and risks weakening existing support if credit prices fall.
Global lockdown measures have caused a sharp drop in demand for road fuels as countries around the world restrict the movements of their citizens. The shock has had a proportionate impact on demand for biofuels, which for the most part are blended into road fuels. Though demand will recover as restrictions ease, the decline in oil prices creates a more challenging competitive environment for biofuels. If oil prices remain near $40/bbl, biofuels will struggle to gain market share beyond minimum blending mandates, capping their potential for growth.
In the air
The crisis is a significant blow to the near-term outlook for bio-jet fuel. Still in its nascency, the cost of producing bio-jet fuel is significantly higher than conventional jet kerosene. With lower oil prices, the competitiveness threshold for bio-jet now looks even more remote. Aviation is also one of the hardest hit industries from the Covid-19 crisis with many airlines requiring government bailouts and others facing bankruptcy. The global aviation sector will likely be greatly diminished by the crisis, so investments in bio-jet programs could suffer. Supportive policies and long-term environmental goals, however, underpin a better long-term outlook for bio-jet.
Pressure on margins
Biofuel producer margins have come under pressure due to the reduced demand, low oil prices and supply disruptions affecting some feedstocks. Prolonged low margins could lead to a wave of industry consolidation.
Policy support mechanisms will be crucial in buoying margins and helping producers to weather the crisis. For example, U.S. biofuels producers earn credits, known as RINs, and biofuels sold in California are rewarded with additional credits under the state level Low Carbon Fuel Standard (LCFS). Both award more credits for lower carbon intensity fuels, like biodiesel and renewable diesel. These fuels could fare better through the crisis due to preferential policy support.
U.S. ethanol producers were already dealing with oversupply and trade barriers prior to Covid-19. As ethanol receives a much smaller boost from credits than other biofuels, BloombergNEF see the U.S. ethanol market at particular risk of consolidation.
Covid-19 has caused several delays to planned policy changes in key markets. For example, Malaysia and Indonesia have delayed plans to increase their respective biodiesel blending mandates.
Reduced demand for road fuels also weakens the value of some biofuel credits by reducing refiners’ blending obligations. This is not yet reflected in U.S. credit prices, however, that have held relatively steady suggesting that the supply of biofuels has fallen in line with the drop in demand. A collapse in credit prices remains a risk in the U.S as refiners are urging the EPA to waive RFS blending obligations in response to the crisis.
On the whole, Covid-19 does not change the environmental aspirations and technological realities facing governments in their fight against climate change. Hard-to-abate oil-consuming sectors, such as long-distance trucking and aviation will be unable to fully decarbonize without biofuels playing a key role, so it is likely that long-term policy support for biofuels will be necessary.
As governments increasingly focus support on less-developed biofuels technologies instead of broad blending mandates for ethanol, we expect the biofuels sector to emerge from Covid-19 more diverse, and sustainable.