One of the major challenges facing us as we transition to a low carbon economy is how we transform our infrastructure to use renewable energy rather than fossil fuels. Clean energy sources such as wind and solar can replace oil and coal in electricity generation, but it will take considerable time and investment to fully electrify certain sectors of the economy and for renewable production capacity to ramp up sufficiently to meet energy demand. Therefore, in the interim, we remain reliant on fossil fuels.

This challenge is why many people view biofuels as a critical component in the transition. Biofuels can be used to help us to lower emissions in the transport sector and can also be used as replacements for coal in power plants to make electricity generation more renewable. However, the story of biofuels is far from straightforward. There are many complexities, caveats and unanswered question surrounding the acquisition and types of fuels used and whether they truly qualify as renewables.

For investors, this is a tricky sector to predict because the success of biofuels will depend on the policies that governments introduce over the next decade. There is certainly cause for optimism though, as companies continue to invest in new technology and continued conversions of legacy fossil fuel infrastructure.  

The Basics of Biofuels

In the renewables landscape, biofuels are perhaps the least well understood by the public. Compared to wind and solar, the biofuel bucket includes a far wider range of different energy sources. To put it simply, biofuels are fuels which are produced from biomass. There are many different types of biomass, but the most popular sources are wood and residues from wood (including palm oil) which are used directly or turned into other forms such as pellets. Other sources of biomass include animal and plant matter such as corn (very popular in the U.S.) which can be converted into biofuel.

The simplest means of using biomass as a fuel is through combustion to produce heat. In fact, in many developing countries, burning wood is still one of the most common forms of energy production. In other countries, biomass is used in the production of electricity as a replacement fuel for non-renewables like coal, or as a liquid fuel in engines for transportation. The most common types of liquid biofuel are bioethanol (often referred to as just ethanol) and biodiesel. Ethanol is often made from crops such as corn while biodiesel is made from oils or fats such as animal fats and palm oil. Both ethanol and biodiesel can be used in pure form but are more commonly added to gasoline (petrol) or diesel to lower emissions.

The Renewability of Biofuels

Technically speaking, biofuels are considered renewable because the amount of carbon dioxide that is released when they are consumed is the same as the amount they absorbed when they were growing. This is also true of fossil fuels such as coal and gas, but the key difference is the timing. Fossil fuels take millions of years to form whereas the biomass for biofuels can be regrown in a few years.

However, their ‘renewability’ is certainly more complicated than this. Because different biofuels are produced and consumed differently all over the world, it is necessary to analyse the life cycle emissions of each different project before making a judgment.

In the UK, which has an emissions target of net zero by 2050, biofuels are currently an integral part of the renewable energy mix. In 2019, more electricity was generated from ‘bioenergy’ than any other renewable energy source (see BEIS chart below). A large proportion of the biomass used as a coal replacement in power plants are wood pellets that are shipped from North America. In this life cycle, there are greenhouse gas (GHG) emissions involved in the production of the biomass (machinery, fertilisers, transport) which need to be accounted for, as well as the emissions from the combustion of the pellets in the plant.

Source: Department for BEIS, Press Notice March 2020

When you consider the full life cycle, it is no wonder that the use of biomass in the UK is a controversial topic. In fact, despite biofuels being included in the government’s list of renewable energies, the UK’s Committee on Climate Change (CCC) recommends that we shift away from biomass. They argue that biomass is not carbon neutral and in some cases can lead to higher GHG emissions than burning fossil fuels.

In addition to life cycle emission analysis, opponents of biofuel also raise other important points. There can be seriously detrimental effects on natural habitats when land is used to produce biomass whether it is from intensive farming in the U.S. to produce corn for ethanol, or from deforestation in Indonesia to create palm oil plantations. The decision to grow crops or trees specifically for use as biofuel also means that there is less land dedicated to food production for humans and animals. This competition for land is having devastating impacts on biodiversity as increasingly governments are reacting to this land shortage by permitting private corporations to turn wild fields and ancient woodlands into more arable land.

So, while most studies agree that the use of biofuels can reduce emissions compared to the use of fossil fuels, it is important to highlight that biofuels should not be thought of as a no-downside, zero carbon alternative.

Investment opportunities

Although biofuels are not perfect, they are still going to play a huge role in the transition away from fossil fuels and this means that significant sums of capital are following in the direction of biofuel projects. In the U.S., some of the largest oil refineries in the West are being converted into biofuel plants. Phillips 66 (NYSE:PSX), an oil refiner with a market cap of over $20bn, has plans to convert one of its oil refineries in California into “the world’s biggest renewable diesel plant”. And they are not alone; their move comes following announcements by some of their competitors such as Marathon Petroleum Corp (NYSE:MPC) and HollyFrontier (NYSE:HFC) who have also decided to convert oil refineries into biofuel plants. These are further signs of the shift occurring in the energy industry away from fossil fuels and towards renewables.

Innovation is also occurring in the transformation of former coal power plants. In the UK for example, the Drax power station in Yorkshire has converted much of its infrastructure to use biofuels rather than coal. Two thirds of the power station now produce renewable electricity by burning wood pellets. The Drax power station is also where new technology is being trialled to try and make biomass combustion a net negative emissions process. Bioenergy with carbon capture and storage (BECCS) could be a critical component of the UK’s ability to reach net zero emissions by 2050. With BECCS at Drax, the carbon dioxide that is released is transported via pipeline for permanent storage under the North Sea, ensuring that no emissions are released into the atmosphere. If this trial proves successful, and it is proven to be able to be done at scale, it will be a huge breakthrough.

The debate will continue as to the extent to which biofuels should be a part of our energy mix. We know that in certain circumstances biofuel projects can be carbon neutral, but for the majority of projects carbon neutrality is simply not feasible. However, we cannot let perfect be the enemy of good in this situation. The reality is that our energy future will rely on exploiting a variety of natural resources as cleanly as possible. If there are biofuel projects which result in lower carbon emissions than the status quo, then they should be encouraged in the near to medium term. Looking forward, policymakers should focus on combustion-free energy sources for large scale power generation and should limit the deployment of biofuels to regions and industries with excess biowaste in the long term.