15/12/06 (The Edge News)  -  Mergers in the booming palm oil sector are creating the biofuel industry's own 'Big Oil' companies, but vertical integration and economies of scale may not be enough to make exports profitable or to replace crude.

Palm oil producers in southeast Asia have high hopes of tapping an emerging biodiesel market in Asia, Europe and the United States, as countries legislate to use crop-based fuels to replace costly oil, improve energy security, and cut emissions.

Shares in palm oil refiner Wilmar International soared on Dec 15 after it announced plans to buy Malaysian plantation assets in a US$4.3 billion (RM15.26 billion) deal, less than a month after three Malaysian plantation firms announced an US$8.6 billion merger to create the world's biggest palm oil group.

The creation of vertically integrated firms who can grow crops, process palm oil and ultimately churn out biodiesel mirrors the structure of oilfield-to-automobile global oil firms.

This will help the emerging biofuel giants limit the risk of volatile feedstock costs and lock in revenues with bigger, longer-term sales contracts, but ultimately neither will guarantee profit in the increasingly overcrowded sector.

"Biodiesel is not viable without subsidies, despite having lower cost structure and scale," said CLSA in a report on Wilmar.

"Only companies with a large enough scale can survive in this space. The costs will be lower with the elimination of some freight and shipping expenses through the integration of their estates and production plants."

Producers of crops such as rapeseed, soy and palm oil have seen soaring prices. A new outlet for supplies looked profitable as oil prices climbed over US$70 a barrel this year.

But most refining of biofuels has been done by small independent firms that risk being caught between rising feedstock costs and an oil price downturn.

"Consolidating assets would not make much difference in reducing costs, unless they can increase supply -- the bottleneck is still on available landmass that can produce feedstocks," said Ibnu Bramono, analyst at consultancy FACTS Global Energy.

A refiner such as Wilmar is dependent on both product prices and feedstocks costs -- the latter can make up 80% of the biofuel cost. And palm oil prices have surged 30 percent this year to be worth the equivalent of US$80 a barrel now, while Asian diesel is only up 6% at US$70 a barrel.

"Wilmar's acquisition would allow it to buy crude palm oil prices probably at a friendly family price discount, thus allowing it to sell biodiesel at a better profit," said a biofuel broker, one of an emerging breed in Singapore, where Joint Asian Derivatives Exchange plans to start a palm oil futures contract.

Wilmar's move will make it the largest palm oil refiner, with about a quarter of global palm oil output, said Credit Suisse.

Analysts say more mergers are likely between those owning crop fields and those looking to supply consumers with motor fuel.

"It's not a good idea to start a stand-alone biofuel plant, which is kind of risky -- it's a good idea for them to be vertically integrated and to secure upstream assets," said Bramono.

Despite the price risks, those markets may be guaranteed through government legislation or subsidies. Indonesia aims for 10% biofuel use while the European Union has a target of 5.75% by the end of the decade. But countries may drop targets if biofuels prove more costly than fossil fuels.

And their aim is for domestic supplies: top Asian consumer China is planning a huge expansion in use of vegetable oils to make biodiesel, while India is looking at hardy jatropha and the Philippines aims to export coconut biodiesel (for biodiesel projects in Asia see

So exporters will have to look to fill niches or take advantage of government requirements that exceed domestic supplies, such as in South Korea and Japan, which are already importing small volumes of feedstocks to meet biodiesel targets.

The larger funds available to merged Asian firms may help them compete with traditional energy firms such as Royal Dutch Shell, in developing so-called second generation biofuels from plant wastes, which are expected to be cheaper than growing crops for fuel.

"Big companies will certainly have more room for research and development, to accelerate technological development towards cellulosic fuels," said Yonghun Jung of the Asia Pacific Energy Research Centre. "It's a good sign for oil consumers because it shows determination." - Reuters