Biofuels (ie, ethanol and biodiesel) are a substitute for traditional fossil fuels and are viewed as ameans of reducing carbon emissions and thereby contributing to the fight against climate change. As a result,many countries have set ambitious biofuel targets (for example, the EU recently set a target for 2012 for biofuels to comprise 10%of their fuelmarket). Biofuels are also a formof energy that is easily transported and stored, and, therefore, tradable. This is particularly significant because whilstmost biofuel demand comes fromthe industrialised world, themost efficient producing countries are located in the developed world. However, despite this, international trade in biofuels is currently very limited.

One of the reasons why trade in biofuels is limited is because of the significant barriers to trade facing the sector and the lack of a clear set of rules governing biofuel trade. For example, both the EU and the US impose significant tariff barriers on biofuels or biofuel inputmaterials. The use of quotas to regulate trade is also a common practice among developed countries. However, arguably themost significant barrier to trade is the financial support, in the formof domestic subsidies, that countries provide to their biofuel industries. This is particularly pronounced in the EU’s and US’s case, where production subsidies are between US$5 and US$8 billion. Such support fromthe US and EU is likely to grow in the coming years because of their strategy of setting biofuel targets.

However, these trade barriers, and in particular the domestic subsidiesmay run afoul ofWTO rules if they have the effect of giving domestic biofuel industries a clear trading advantage over foreign ones (or because subsidised biofuel input products will be cheaper, divert customers in foreign states away fromthe products of non-subsidising countries towards the products of the subsidising country).

The WTO rules ofmost relevance are the General Agreement on Tariffs and Trade (GATT), the Agreement on Subsidies and Countervailing Measures (SCMAgreement) and the Agreement on Agriculture (AoA), all of which contain clauses regulating the use of subsidies. However, there are no uniformrules specifically applicable to biofuels because they came into existence after theseWTO agreements, and countries have been unable to reach any consensus in themeantime. The main problemis that biofuels do not enjoy consistent tariff classification. For example, under the harmonised systemof classification (HS) used by theWTO, while biodiesel is classified as an industrial product, bioethanol is classified as an agricultural product. This is significant because it potentiallymeans that bioethanol will be subject to the AoA and the SCM Agreement, whereas biodiesel will only be subject to the provisions of the SCMAgreement. The uncertainty regarding biofuel clarification also leads to vagueness inWTOMembers subsidy notification requirements and according to Haverkemp and Parker “risks stunting growth in trade even as the global demand for biofuel increases”.

The need for greater clarity on international trade rules for environmental subsidies, and in particular, biofuel subsidies, has been given a new urgency by three recent developments:

WTO panel established to rule on subsidies for US corn (an input for biofuels): on 17 December 2007, theWTO’s Dispute Settlement Body established a panel to examine Brazil’s and Canada’s requests on US farmsubsidies and domestic support. Both Brazil and Canada claimthat US subsidies to its farmers are contrary to the SCMAgreement and the AoA.

Canada estimates that theUS exceeded the level of its authorised subsidies by billions ofUS dollars each year. TheUS reportedly replied that its farmprogrammeswere designed to be in compliancewith itsWTOobligations and believed the panelwould agree.

The panel is expected to issue a ruling during the course of 2008.

EU biodiesel industry to launch legal action against US biodiesel exports: the EU is being pressured by European biofuel companies to take action to stop American rivals importing subsidised fuel into the Europeanmarkets. In a press release of 3 December 2007, the European Biodiesel Board (EBB) agreed to lodge a complaint to the European Commission against US B99 exports, which they allege are jeopardising the concept of international trade in biodiesel. According to the press release, the legal action will take the formof a joint anti-dumping and anti-subsidy complaint, possibly supported byWTOmeasures at a later date. If successful, this could result in the EU placing duties on US imports.

The EBB contends that under the current system, US companies are entitled to federal government subsidies and rebates offered by EUMember States. This is because due to US laws adopted in 2004, biodiesel can be subsidised up to approximately €200/tonne only by adding a “drop” ofmineral diesel to biodiesel. US producers can then claimthemaximum subsidy for a “B99.9” blend. This blend can then be exported to the EU where is it also eligible for subsidy schemes.

The EBB claims that the subsidies are unfair and EU producers have come under pressure fromgrowing sales of cheap US biodieselmade with the help of subsidies.Member Statesmost affected include Germany, Spain and the UK. According to the EBB, price competition has erodedmargins for EU producers, forcing some out of business and has led to stagnation or even decline in EU biodiesel output this year.

The problems came about due to a tax credit passed by the US Congress in 2004, which was intended to promote the US biodiesel industry. The tax credit equals a dollar for every gallon of biodiesel blended in the US. This was done to encourage marketers of normal diesel to blend in plant-based fuel and so broaden the use of biodiesel. However, the systemhas a loophole, referred to as “splash and dash”. This practice involves transporting biodiesel produced elsewhere (eg, in Indonesia orMalaysia), to the US, adding just a “splash” of US-made petroleumdiesel, then shipping the “blend” to Europe for sale. The US Congress is currently considering a bill that would just permit companies to claimthe subsidy on biofuels used in the US. However, the billmay takemore than a year to become law.

Attempts to promote “sustainable” biofuelsmay lead toWTO dispute: there is a growing concern over the harmful effects of certain biofuels (particularly, palmoil which is the cheapest andmost readily available and has resulted in deforestation in Borneo and Indonesia). This has led for calls for the EU to only import biofuels that are produced from sustainable resources and the EU carried out a consultation exercise in January 2007.

However, because there is currently no internationally agreed definition of a “sustainable biofuel”, if the EU, or any other country, were to invent one unilaterally, it could be the subject of a challenge underWTO rules. Brazilian officials have indicated their displeasurewith such a programrequiring that biofuel imports be certified as coming fromsustainable sources. Brazil contends that itmight be construed as a non tariff barrier, which could be grounds for aWTO dispute settlement case.

The next official step is the adoption ofmeasures as part of a legislative proposal, which is currently slated for 23 January 2008. Under the EU plans, sustainability criteria or a certification systemwould be established that would apply to imports as well as domestic production. The sustainability criteria would include environmental and social aspects of global biofuels production. The sustainability discussion was initially championed by the Netherlands, Germany and the UK after several experts claimed that certain biofuels had a negative greenhouse gas impact  on the environment.

Conclusions: international demand for biofuels will increase over the next few years, but unless subsidies and other market distortions are removed, international trade will be limited and will favour the US, EU, and other developed countries. According to the International Institute for Environment and Development (IIED), international trade barriers and subsidies need to be relaxed for developing countries to benefit frombiofuels trade. Furthermore, unless there is improved international coordination,WTO disputes are increasingly likely which will only serve to undermine the growth in this sector.