Governors' Biofuels Coalition

•  Ethanol will remain a small percentage of the fuel used in China’s transportation sector.
•  Without a significant policy shift, China will continue to rely on domestic supplies for most of its ethanol needs.
•  China may increase ethanol imports to a limited extent, but Beijing’s strategy to secure supplies beyond domestic production will focus on investments abroad in both ethanol production and agricultural operations to grow the necessary feedstocks.

In recent months, China began importing ethanol from Brazil for the first time since 2012 via a joint operation between China National Oils and Foodstuffs Corp. and Noble Group. The Chinese firm purchased a controlling stake in Noble Agri Ltd. in 2014, giving it access to a vast global supply network for agricultural commodities. And in the first half of 2015, China sourced a total of 56,000 metric tons of imported ethanol from Brazil, Pakistan and the United States — more than twice its imports in all of 2014. These developments have fueled optimistic speculation that ethanol could be an outlier in China’s broader trend of slowing commodity demand, representing an emerging market for major ethanol producers such as Brazil and the United States.

But while we could see sporadic increases in Chinese ethanol imports from operations where the country does not have investments, the decision to increase ethanol imports is more likely a small part of Beijing’s broader investment strategy of ensuring security through investments abroad across a range of supply chain stages. A prolonged rise in Chinese ethanol consumption would require both continued growth in the automotive sector and government policies mandating the use of ethanol as a transportation fuel. But given Beijing’s lack of policy support for expanded ethanol mandates and given competition from alternative technologies in China, the potential for near-term growth in Chinese ethanol demand will remain limited.

Automotive Factors

Weakening growth in China’s housing and construction sectors has become the new norm, carrying several implications for the country’s ethanol consumption. Most significant, it has eroded consumer confidence, which has hurt the automotive sector. This is important because fuel ethanol accounts for roughly one-third of all ethanol produced in China and more than half of the country’s consumption of industrial-grade ethanol. Prior to the recent slowdown, personal vehicle sales had been surging as China’s middle class grew and cars became more affordable. Now, the double-digit economic growth rates of just a few years ago are a thing of the past. As a result, auto sales growth slowed in 2014, and 2015 is expected to be even worse for the sector. Indeed, the first quarter of this year saw only 4 percent growth in total vehicle sales, compared to 9 percent a year earlier. Sales actually declined in June and July of 2015.

But even with the auto sector slumping, fuel consumption continues to rise because of the increasing popularity of SUVs and other fuel-intensive vehicles. And despite fewer new vehicle purchases and limited ethanol blend mandates, China’s sheer size has kept demand for the biofuel at about 2.3 million metric tons — a hefty figure, even though ethanol currently accounts for only about 1 percent of total Chinese fuel consumption.

Meanwhile, the environmental movement is gaining steam in China, giving rise to calls for lower carbon fuels. Beijing has pledged to reduce carbon emissions, and ethanol blend mandates are in place in six provinces (Heilongjiang, Jilin, Liaoning, Anhui, Henan and Guangxi) and several cities in other provinces. Actual blend rates are between 8 and 12 percent and are highly dependent on domestic production. By comparison, Brazil recently increased its blend mandate to 27 percent. The present lack of governmental support for increased mandates will limit ethanol consumption growth in the short term.

But ethanol blending could gain traction in the long term as China attempts to curb carbon dioxide emissions. Expanding ethanol blending would seem like a simple way to achieve such reductions, since it is relatively inexpensive and the infrastructure for it is already in place. But Beijing seems to favor promoting the use of electric vehicles, which have benefited from significant government investment in charging infrastructure, subsidies and tax breaks, and mandates for state use. As the cost of electric vehicles continues to decline, they will become even more competitive with traditional vehicles. The use of natural gas vehicles could also be expanded to reduce emissions, especially for public transportation, likewise at the expense of ethanol demand.

The Search for Self-Sufficiency

Chinese demand for imported ethanol is heavily affected by other policy factors as well. In particular, Beijing currently bans the use of imported ethanol for transport fuel. Unlike other industries such as steel and coal, China’s biofuel sector is highly concentrated and run by a limited number of state-owned companies. Marketing and distribution also fall under the purview of state firms. Given the heavy state involvement in the sector, there is limited room for it to deviate from Beijing’s broader goals. The state-owned energy companies do have political heft, but given the ethanol sector’s relative lack of significance, we are unlikely to see significant pushback against the current policy.

As a result, imports of denatured ethanol at present are used primarily for industrial purposes. And demand for transport fuel, which has increased by about 5-6 percent annually for the past three years, remains wholly dependent on domestic production.

For its part, domestic ethanol production faces many of the same constraints as China’s agricultural sector, namely, limited land and water. Currently, about 75 percent of China’s ethanol production comes from corn. In 2015, however, Beijing removed government subsidies of grain-based ethanol, focusing instead on alternative feedstocks such as cassava, sorghum and cellulosic ethanol production to eliminate competition between fuel and food users of dual-use crops. Official policy now seeks to limit so-called first-generation ethanol production, such as ethanol made from corn, in favor of “1.5-generation” production, such as ethanol made from sorghum and cassava, and second-generation production, such as cellulosic ethanol made from switch grass or other non-food sources.

Even before Beijing’s support for first-generation plants declined, production was falling short of stated goals. China’s current five-year plan calls for 5 million metric tons of biofuel production in 2015, including 4 million metric tons of ethanol. But production will likely reach only somewhere between 2 million and 3 million metric tons. As with other agricultural products, China’s strategy for self-sufficiency in ethanol must therefore adapt to resource constraints.

Looking Abroad for Ethanol

Given its domestic supply limitations, China may indeed look outside its borders more to meet its ethanol demand. This would fit with Beijing’s broader foreign investment strategy of ensuring security by investing abroad in a variety supply chain stages. China National Oils and Foodstuffs Corp.’s investment in Noble Agri Ltd. falls under this broader trend. In addition, China New Energy Ltd. has invested in ethanol plants in Hungary, Thailand and Nigeria. Henan-Tianguan Group Co. Ltd. — one of China’s largest fuel ethanol producers — grows cassava in Laos and has imported cassava from Cambodia for use in its Chinese plants, and it plans to build an ethanol plant in Laos.

China has invested heavily in a number of other agricultural ventures in recent years as well, several of which could provide feedstock for Chinese ethanol production. These include Ord Valley in Australia, where sorghum is currently grown and aspirations to eventually grow sugar (which could be used to produce ethanol) remain. On the second-generation front, Jilin Province New Tianlong Industry Co. recently signed an agreement to license cellulosic fuel technology from DuPont.

n 2014, Beijing conducted a trial run via a state oil company testing the economic feasibility of importing ethanol. The test showed that imports could be economically viable, especially given low corn and sugar prices. As noted, imports — though small — have increased. And the surge of Chinese soybean imports in the 1990s and early 2000s are a prime example of what can happen when China opens its doors.

Nevertheless, so long as Chinese regulations prohibit the use of imported ethanol as a transport fuel, Chinese demand for foreign ethanol is apt to remain small. We may instead see growing interest from Chinese companies in investing abroad in parts of the ethanol supply chain and perhaps smaller opportunities for exporters to China as policy allows. Ethanol is therefore unlikely to be a bright spot in China’s slowing demand for commodities on the global market.

This article was originally published by Stratfor, a leading global intelligence and advisory firm based in Austin, Texas. 

 

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