Taxing time for European biodiesel

Can a thriving industry collapse because of tax policy? That appears to be happening in Germany and perhaps elsewhere. If true-what does it mean for biodiesel worldwide?
By Jon Evans | May 14, 2008
Many countries provide incentives, mainly in the form of tax credits, to help biofuels compete with fossil fuels. The intent may be admirable and tax credits may be critical for establishing a healthy demand for biofuels.

Yet such tax policies often cause a great deal of trouble, both for those they were intended to help and for innocent bystanders.

This is now the case in Europe, where an inadvertent combination of U.S. tax policy and the phasing out of tax credits in Europe's largest biodiesel market is pulling the legs out
from under a once-thriving European biodiesel industry.

The so-called splash-and-dash tax credit faces phase-out in the United States this year, but the European Biodiesel Board is seeking legal action nevertheless and European Union trade reprisal may be coming.

Splash-and-dash, however, is only one element in tax mayhem that biodiesel is battling in Europe and elsewhere. As in the United States, European governments have set up tax-credit systems for biodiesel to provide support for domestic markets and industries. In Europe, these tax credits are in the form of reductions in the excise tax paid at fuel pumps-benefiting consumers rather than producers.

This kind of arrangement builds demand for biofuels. In contrast, the U.S. producer-tax credit assists mainly in building up production capacity, says Will Thurmond, a biodiesel consultant in Houston and author of the report "Biodiesel 2020: A Global Market Survey."

The German Factor
What happened? In Germany, generous tax treatment led to a 17-fold production rise from 200,000 metric tons of biodiesel from rapeseed in 2000 to 3.4 million metric tons (60 million to 1 billion gallons) in 2006.

The German government, however, was losing revenue by not taxing biofuels, about $3 billion in 2006. On Jan. 1 of this year, Germany imposed the U.S. equivalent of 9 cents per liter of biodiesel-about 34 cents per gallon. And the tax is scheduled to rise.

The far-reaching upshot has been more biodiesel imports-much of it via the United States because its inadvertent splash-and-dash loophole, which allows a $1-per-gallon tax credit for imported B99 to which as little as one-hundredth of 1 percent petroleum diesel is added in a U.S. port before re-export.

Meanwhile, every European country has set its own level of reduction in its excise tax, which can range from 100 percent to 55 percent. At the same time, however, each country in the European Union is also part of a single European market-which means that biodiesel producers in any EU member country can freely sell their biodiesel into any other EU country. The result is that the specific tax-credit arrangements in the largest national market for biodiesel, Germany, has an enormous effect on the whole European biodiesel industry. "Germany," says analyst Thurmond, "is the magnet and driver of biodiesel in Europe."

Over the past few years, Germany has been by far the world's largest biodiesel producer, with almost 2.7 million metric tons (815 million gallons) in 2006. Consumption kept pace with production-until 2007.

Tax Holiday
Biodiesel's popularity in Germany was primarily a result of tax policy. At the pump it was subject to no excise tax at all, making biodiesel much cheaper than most other fuels. This led to biodiesel capturing a whopping 12 percent of the German fuel market, compared with less than 1 percent for the EU as a whole.

Like all holidays, however, this retail tax holiday was never meant to be permanent. The German government began to phase in a tax in 2007. It immediately dried up demand for biodiesel in Germany. Biodiesel now accounts for as little as 2 percent of the German fuel market, according to Thurmond.

The drop in demand in Germany, the largest single EU market for biodiesel, has had a ripple effect on the whole European biodiesel industry, especially producers in Germany and neighboring countries. About 75 percent of Germany's biodiesel production capacity now lies idle, by some accounts.

Tax credits tend to be temporary, primarily designed to stimulate the growth of a nascent industry and market and withdrawn when the sector can stand on its own. Other support mechanisms may have the same effect. For instance, in the United States and the EU, tax credits are giving way to requirements that biofuels make up a certain proportion of the overall fuel supply.

Pain and Gain
Is it the case that a seemingly viable industry, with profitable companies and healthy demand, may only be so because of a tax credit? Might both profits and demand disappear along with the tax credit, as appears to be happening in Germany? If governments wish to foster biofuels growth, what's the right balance?

Across Europe as a whole, the pain caused by the loss of the German tax credit has been exacerbated by a spike in prices for vegetable oils, the main feedstock for biodiesel, which has tripled in price over the past year. Together with the "splash-and-dash" loophole, this is all creating a tough business environment for European biodiesel producers-forcing firms out of business or into mergers.

So what does it all mean for the future of tax policy and biodiesel? Europe's biodiesel industry isn't ready to stand on its own without tax breaks "at the moment," says Werner Langen, member of the European Parliament and chairman of its conservative Christian Democratic Union-Christian Social Union party. "But, sure, the aim in the future should be to have a biodiesel industry in Europe without tax breaks and with larger operations."

If Europe wants sustainable energy, biodiesel will be a key component and tax policy may well need to support that, Langen argues. Best would be a Europe-wide tax policy. "Only with such a policy can we support this important industry for the future," Langen says. "All in all, biodiesel must be a part of an independent European energy policy. That is our aspiration."

In the interim, biodiesel producers and consumers will endure some havoc. For some companies it will indeed seem that tax-policy changes can bring down a flourishing industry, Thurmond suggests. Ultimately, biodiesel must stand on its own without tax credits, he agrees. Eventually, cheaper second-generation feedstocks will help.

Meanwhile, one irony is this: In Germany, the tax credit was aimed at the consumer, stimulating demand until the government phased out the credit starting in late 2006. In the United States, on the other hand, the biodiesel tax credit is aimed at the producer, and has helped stimulate tremendous growth in biodiesel plants and production capacity-but the credit hasn't stimulated growth in consumer demand. Only 4 percent of U.S. passenger vehicles run on diesel, compared with more than 50 percent in Europe.

So the splash-and-dash loophole isn't the only reason U.S. producers are shipping to Europe. Tax policy notwithstanding, good old supply and demand is still in play. The diesel price in Europe is higher-$9 per gallon in the United Kingdom versus more than $4 per gallon in the U.S. Moreover, demand in Europe is greater.

Producers benefit from tax credits, but still must tend the basics: They need cheaper feedstocks, such as yellow grease, and higher prices for the end product.

Thurmond predicts that, for biodiesel producers, "profits will diminish but will not go away." Big, vertically integrated operations will make money even without a credit. Small plants using cheap local feedstocks can do business as well. "The tax credit in both cases is a stimulus, not a necessity," Thurmond says. "The market will eventually find a way to make biodiesel profitable without tax benefits."

The Right Balance?
Finally, then, if governments want to foster biofuels growth-what's the right balance?

In the United States, soybean growers pushed for tax incentives but didn't coordinate with oil companies and government, Thurmond argues. This resulted in high soybean prices, but left producers where they are today, with idled plants virtually next to fields full of soybeans that producers can't afford.

Brazil, China and India have planned more comprehensively, involving all the stakeholders, Thurmond says. "A collective, collaborative" U.S. effort involving political and industry stakeholders could create a roadmap that would help rebalance the industry, he thinks.

In short, tax credits may have the best intentions-though the effects can be anything but.

Jon Evans is a freelance science writer and editor based in Chichester, UK. He mainly focuses on the chemical and life sciences, covering everything from biofuels to nanotechnology, and is a regular contributor to a number of scientific magazines and Web sites, including Chemistry World and Biofpr.
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