8/6/06 NEW YORK (Reuters) - Biofuels have the potential to replace growing amounts of oil, but can cause agricultural and ecological damage if not not developed carefully, a report released on Wednesday said.

The market for biofuels, which include ethanol and biodiesel, is small but growing rapidly. Between 2000 and 2005, ethanol production doubled. In the same period, biodiesel output quadrupled, though it started from a smaller production base.

Still, in 2005 the global ethanol supply fueled a little less than 1 percent of the distance traveled by the world's transport vehicles.

Soon biofuels could replace more oil, new supplies of which are becoming harder to find and produce. Biofuels could provide 37 percent of U.S. transport fuel within the next 25 years, according to the report, Biofuels for Transportation.

In the European Union, biofuels could replace 20 to 30 percent of oil-based fuel during the same time frame, said the report, published by the Worldwatch Institute, a Washington-based advocacy group, and commissioned by a German agricultural agency.

Biofuels could mitigate some of the environmental risks of the drilling and burning of oil, but can spur ecological risks of their own, if not managed well, the report said.

In Brazil and Asia, fields of soybeans and palm, whose oils have the potential to become significant sources of biodiesel, are encroaching on tropical forests, which hold great wealths of biodiversity, the report said.

"The most problematic and serious risk (of biofuels) is of spreading into wild areas and impacting biodiversity," Christopher Flavin, president of Worldwatch, said in a telephone interview. "That is going to require more stringent laws than currently exist in most countries," he added.

In addition, growth of biofuels could drive up food prices by diverting crop yields to produce fuel, which could make it more difficult to feed urban poor, according to the report.

Traditional ethanol crops, such as corn in the United States and sugar in Brazil, could also increase erosion and deplete aquifers.

And, if biofuels are produced from crops that take high inputs of products derived from fossil fuel, such as fertilizer, the process of growing, making and burning the fuel could create more greenhouse gas emissions than oil does, the report said.

Stricter land-use laws, particularly in countries with tropical forests, are needed to mitigate potential damage and reap the benefits from biofuels, it said.

In addition, no-till crop techniques and the use of advanced biofuels, such as cellulosic ethanol, can cut carbon dioxide emissions below those from fossil fuels.

Cellulosic ethanol uses microbes to break down the woody bits of plants. The advanced biofuel can be made from low-imput perennial crops, such as switchgrass, that grow on marginal lands.

The cellulosic ethanol industry is in its infancy, however. Currently there is only one such plant in North America, run by private Canadian company Iogen, with investments from Royal Dutch Shell and Goldman Sachs & Co.

Biofuels are also a source of jobs. The ethanol industry provides 200,000 jobs in the United States and 500,000 jobs in Brazil, which produces slightly more ethanol than the United States, the report said.