Oil Market Report June, 2015

Back in March, we looked at Canada’s Tar Sands and explored how low oil prices were having such a profound effect on this key Canadian industry. But with prices continuing to stay low, the tar sands are by no means the only sector feeling the pain. In Aberdeen, where the UK’s offshore industry is based, there has been much media focus on the 15,000 (optimistic?) to 25,000 (pessimistic?) forecasted job losses over the next 5 years, as oil producers scale down their operations. But there has been relatively little interest in a much smaller part of the oil industry that is also bracing itself for hard times ahead; biofuels.

Looking at the graph attached, the rub with biofuels is fairly obvious. It is a lot more expensive than normal refined products and that situation has got a lot worse since oil prices plummeted at the end of 2014. This time last year FAME Biodiesel (Fatty Acid Methyl Ester – this is the main Biodiesel grade) was trading at around $1,000 per tonne (about 52 pence per litre), whilst Diesel hovered around the $900 (45ppl) mark – a difference of $100 (7ppl). But fast forward 12 months and we see that price differential rising to $230 per tonne (13ppl), having hit a massive $360 per tonne (20ppl) differential in January. Such large disparities in price basically mean that without subsidy, biofuels cannot compete with normal refined grades of fuel such as diesel and petrol.

Hold on a minute I hear you say. Surely minimum levels of usage have been set for biofuels across Europe, which means that biofuel has to be used whatever the price? Well that is indeed true, with the level set in the UK at 4.75%, Germany 6.25%, France 7% and so on. On the surface this seems to present a solution to the problem, but as ever in the oil industry, things aren’t that simple once you scratch below the surface.

Firstly, like all businesses, biofuel producers want to sell as much as possible rather than just a mandated minimum volume. And with many engine warranties now accepting much higher blends of biofuel (up to 10%), there is in theory an opportunity to sell much more product. In fact – mathematically speaking – a 10% blend versus an average mandated biofuel minimum of 5%, gives scope for a doubling of sales. But this can only ever happen when the price is right and biofuel prices at the moment, are most definitely not right! Only the worst buyer in the world would voluntarily purchase a product that does the same thing as standard diesel (and is fundamentally of lower quality) but costs up to 20ppl more!

Of even more significance is the way that fuel sellers are permitted to meet their obligated biofuel targets. On the one hand, they can sell all of their fuel at the required 5% level, ie, 5 litres of Biofuel must be blended with every 95 litres of standard fuel sold. But they also have the option of supplementing the Biofuel with bio certificates (Renewable Transport Fuel Obligations = RTFO’s) in lieu of the actual product. In theory these certificates should be more expensive than the biofuel itself, meaning that there is an incentive to blend the full amount of volume and not buy the certificates. But with such a massive price differential existing between for example standard Diesel and Biodiesel, fuel suppliers are more than happy to sell fewer bio litres and simply top things up with readily available RTFO’s. In theory as demand for RTFO certificates goes up, so will their price and at that point, we should see fuel suppliers going back to selling fully blended Biofuels. But such has been the scale and rapidity of the recent price drop of standard oil products, this does not look like happening any time soon. Basically, the less dynamic RTFO market is struggling to keep up with the much more volatile oil market and for the biofuel producers this means less volume.

That the low oil price generates more winners (consumers) than losers (producers) is beyond doubt – but for the relatively nascent biofuels industry, low prices are indeed bad news. It’s also bad news for their suppliers. What for example, is the immediate outlook for Europe’s rape seed growers whose annual 20m tonne harvest predominantly (about 60%) goes into the Biofuels industry? And all of this in an industry whose operations have been under significant scrutiny from day 1; should land be used for “growing” fuel rather than food? How many acres of rain-forest have given way to palm oil plantations for the supply of Biodiesel? Are some of the energy intensive biofuel processes (eg, ethanol from corn) really any greener than simply getting crude out the ground and refining the stuff in the normal way? Then to cap it all the survivors of this fragile sector face the prospect of selling an uncompetitive product, possibly for months or even years to come. That’s a tough position to be in and a sector that relies on either permanent high fuel prices or government intervention doesn’t feel – to this observer at least – like a long-term winner.