04/11/2007 (The Wall Street Journal Online) - Rising costs of biofuels and other alternative energies are making them less viable as substitutes for crude oil, a development that could frustrate efforts to bring oil prices down in the years ahead.

A few years ago, many energy economists predicted that higher oil prices would ensure the success of alternative energies such as biodiesel or wind power by making them more financially attractive. In many cases, though, the opposite has occurred: Even as crude-oil prices approach $100 a barrel, some alternatives look less attractive than in the past.

One reason: Energy demand is now so intense that supplies of just about every kind of fuel are in short supply, driving up prices of the raw materials involved in making many alternative energies. Some biofuels also rely on agricultural commodities that already are facing higher demand as foodstuffs, a situation which drives up prices further.

The problem is most acute for crop-based alternative fuels, like ethanol and biodiesel, though it has also proved true to some degree for solar power, nuclear power and other competing energy sources.

Biodiesel, a fuel made from farm crops like soybean oil and palm oil, was in some cases supposed to be economically competitive with crude-oil prices as low as $50 a barrel, according to analysts who studied the industry.

But a sharp rise in the price of biodiesel raw materials -- including a more than 90% jump in palm-oil prices over the past three years -- has dramatically altered the economics of the industry. M.R. Chandran, former head of the Malaysian Palm Oil Association, says crude oil would now have to be as much as $130 a barrel before palm-oil-based biodiesel is competitive.

Other alternatives to oil, including relatively dirty ones such as coal, have also become more expensive. Coal prices have more than doubled over the past four years, and prices for uranium, a crucial ingredient in nuclear power, have increased more than sevenfold in that time frame. The cost of solar-power cells has been pushed up in the past few years by a tight supply of silicon, the main raw material in such cells.

"The cost goal posts have certainly shifted," and that is making it harder for alternatives to oil to gain traction, says Peter Tertzakian, chief energy economist with ARC Financial Corp., a Calgary, Alberta, private-equity investor. As a result, "the rate of adoption that people expected is going to be a lot slower than people think."

Of course, many types of alternative energy have made considerable progress over the past three years, and crude-oil prices would almost certainly be higher now if such fuels weren't in the mix. Asia and other parts of the world have rolled out billions of dollars for new nuclear-power plants and liquefied-natural-gas facilities over the past several years, and spending on solar and wind power also has soared.

Global ethanol production rose 25% from 2004 to 13.5 billion gallons last year, and biodiesel capacity more than doubled to 6.1 million metric tons in that period, though the two combined still only make up about 1% of the world's transportation-fuel supply. Biofuels -- along with oil from the former Soviet Union and Brazil -- are expected to account for much of the new energy supply developed outside the Organization of Petroleum Exporting Countries next year, the International Energy Agency says.

Perhaps most important, huge sums of venture-capital cash have flooded into the alternative-energy sector since 2004, raising the odds that technological advances will bring down costs in the years ahead.

"It's early in the game; it's only been four years since energy prices have risen, and I think we're all just too impatient," says Mark Zandi, the chief economist of Moody's Economy.com, a West Chester, Pa., research firm.

Still, the latest surge in alternative-energy costs -- along with growing concerns about their environmental sustainability -- are forcing governments to rethink their commitment to such fuels. Some have begun to question whether they will play as big a role in the future as first hoped.

In Malaysia, an important center for palm-oil biodiesel production, the government has held back on plans to require biodiesel blends at petrol stations because of a fear it could drive palm-oil prices too high, imperiling the country's nascent biodiesel industry.

Malaysia issued roughly 90 permits for biodiesel refineries in the past three years, but only about five are in operation. It appears that most of the others will remain on hold until palm-oil prices come back down.

In Europe, officials are still committed to a plan to meet 10% of the region's transportation needs with biofuels by 2020. But Germany has cut back on some tax incentives for biofuels, and some EU officials have questioned whether subsidies for biofuel crops are necessary in the future. Spanish energy company Abengoa SA recently suspended production at one of its biofuel facilities in Spain because of high grain prices. Similar projects have stalled elsewhere, including Hungary.

The U.S. has its own alternative-fuel woes. The price of corn, a key raw ingredient, has increased even as the market price for ethanol has been held down by oversupply. That has squeezed the profitability of ethanol producers and forced new players to cancel or delay construction of more facilities.

Some economists now fear that the current problems may remain as long as oil stays expensive and won't be easily fixed in the short term. They note that some nonoil fuels face the same supply constraints as crude oil. There may not be enough land or water to produce all the crops needed to keep biofuel prices low. Coal, while still plentiful, faces deteriorating grades and rising costs in older mines. Uranium supply is limited by the long lead times required in developing new mines, among other factors.

Another concern is that as more nonoil commodities evolve into oil alternatives, they will start to be priced the same way as crude, keeping their costs in line with international oil prices.

Before the latest energy boom, for instance, palm oil was viewed primarily as a source of cooking oil, and its value didn't rise and fall with crude oil. Now, it is increasingly seen as an energy source. Over the past three years, palm oil's price has risen by roughly the same amount as crude oil.

But there are signs some of these fears may be overblown. The price of sugar, a key element of ethanol, has dropped more than 40% since early 2006 as supply expands in places such as India.