19/10/2007 (AFX News Limited), KUALA LUMPUR - Record oil prices have boosted demand for biofuels as consumers and companies look for cheaper and cleaner energy sources, but there are growing concerns that the various substitutes for gasoline and diesel may be doing more harm than good.

Biofuels like ethanol and biodiesel have been widely viewed as the answer to reducing greenhouse gas emissions but critics warn that a reliance on them could lead to higher food prices, deforestation and ultimately, do more damage to the environment than the fossil fuels they are supposed to replace.

'The use of food as a source of fuel may have serious implications for the demand for food if the expansion of biofuels continues,' the International Monetary Fund said Thursday.

The Washington, DC-based agency called for greater international coordination to ensure that policies promoting biofuels take account of their impact on consumer prices.

The concerns come as oil prices continue to set fresh records. The front-month futures contract spiked above 90 dollars a barrel in after-hours trade in New York earlier as mounting tensions in the Middle East exacerbated supply concerns heading into the US winter heating season.

The high oil price has pushed the price of crude palm oil, a key source of biodiesel, sharply higher in Malaysian trade.

Crude palm oil (CPO) futures traded on the Malaysian derivatives exchange hit a record on Friday, with the benchmark January contract rising to 2,784 ringgit per metric ton.

'The rally in crude palm oil price was largely due to the record crude oil price, which would directly boost demand for biodiesel as a substitute to petroleum products,' said James Ratnam, an analyst with TA Securities.

Palm (nasdaq: PALM - news - people ) oil is cultivated from the fruit of the palm tree and is widely used in Asia as a cooking oil and to make soap. China and India are the two major buyers of Malaysian palm oil.

Fueling the boom

Malaysia and Indonesia, which together account for more than 85 percent of global palm oil production, have invested heavily in expanding their palm oil-based biofuel industries in recent years.

In Malaysia, the government had granted 92 licenses to set up biodiesel plants at end July, while the Indonesian government has allocated some 5-6 million hectares of plantation land for biofuel projects.

Demand for biofuel looks promising as developed nations switch from conventional energy sources to comply with the conditions agreed in the Kyoto Protocol, said Yeah Kim Leng, chief economist at Rating Agency Malaysia (RAM).

The international treaty requires developed countries to cut greenhouse gas emissions by at least 5 percent in the period from 2008 to 2012.

'The switch to cleaner energy will ensure rising demand for biofuel,' Yeah said.

Biofuels can be produced from any carbon source, including vegetable oils like palm oil, soybean oil and rapeseed oil. Research in the US has shown biofuels like ethanol and biodiesel could cut greenhouse gas emissions by up to 40 percent.

Oil palm has the highest oil yields among oilseed crops, which makes palm oil the most environmentally-friendly answer to rising demand, Credit Suisse said in a recent report.

'We are generally still bullish on CPO prices,' said Ting Min Tan, Malaysia-based analyst for Credit Suisse. 'If crude oil prices continue to go up, the economics of using palm oil as a biofuel improve.'

OSK Investment Bank analyst Alvin Tai said palm oil supply may exceed expectations next year as production in Indonesia recovers after the severe flooding early this year.

That could lead to a downcycle in palm oil prices in 2008, although any fall will be limited by huge demand from the biodiesel plants that have already been built and those currently being built, he said.

Environmental cost

But Malaysia-based conservation organisation Wild Asia said the focus on expanding oil palm acreage for biodiesel, will ultimately, be unsustainable given the scarcity of land.

'Aside from the environmental issues involved, I do not see how you could efficiently manage larger land holdings where there is already a cry for a reliable labor force and an aging population of skilled, experienced managers,' said Wild Asia director Reza Azmi.

'Any growth that is dependent on increasing developed land area will be of concern. New land developments are being focused where there is still cheap available land, often these are on marginal soils or in more undeveloped regions, many may be forested lands,' he said.

The Organization for Economic Cooperation and Development (OECD) has called on governments to cut their subsidies for biofuel and instead encourage research into technologies that would avoid competing for land use with food production.

It said biofuels may 'offer a cure that is worse than the disease they seek to heal'.

'The current push to expand the use of biofuels is creating unsustainable tensions that will disrupt markets without generating significant environmental benefits,' the OECD said.

'When acidification, fertilizer use, biodiversity loss and toxicity of agricultural pesticides are taken into account, the overall environmental impacts of ethanol and biodiesel can very easily exceed those of petrol and mineral diesel,' it said.

The IMF agrees that the growing use of biofuels could create imbalances.

'One country's policy to promote biofuels while protecting its farmers could increase another (likely poorer) country's import bills for food and pose additional risks to inflation or growth,' the agency said.

The effect on food prices could be eased if the United States and the European Union reduced barriers to biofuel imports from developing countries such as Brazil, 'where production is cheaper, more efficient and environmentally less damaging.'

(1 US dollar = 3.38 ringgit)