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Thursday, March 09, 2006

Biofuels Indices and the Globalization of Trading in Biofuels

The first biofuels index was launched this week—the UBS Diapason Global Biofuel Index—by Swiss bank UBS and commodity firm Diapason. The index should allow all parties along the biological fuels chain (Biomass Feedstock Information Network) to increase their exposure to opportunistic fuels that are derived from agricultural and organic waste sources. By providing a pricing benchmark, biofuels producers, consumers and investors can enter into contracts to hedge their exposure to volatile biofuels prices. The index composition is 30 percent ethanol and 29 percent sugar, and smaller weightings in wheat, barley, rice, lumber and a biodiesel component.

The index, to be denominated in USD, EUR, CHF and JPY, also reflects the globalization of the biofuels industry.
Part of the economic case for biofuels has always been the ability to use on-site opportunistic fuels, thereby eliminating fuel costs and the transportation costs associated with natural gas and oil. The leading example is Brazil’s use of its domestic sugar cane industry to make ethanol to power its transportation sector. In today’s high natural gas and oil price environment, however, it is becoming more economical to ship biofuels across the world’s oceans like oil and liquefied natural gas (LNG).

A recent BBC article says that Japan wants to import six billon litres of Brazil’s ethanol by 2008. The exporting of wood chips to Europe for use in power generation is becoming a growing business for Canada’s lumber industry. Closer to home, President Bush estimates that the United States’ sizable surplus of wood chips and switchgrass could meet 10 percent of energy needs one day. Yet until the US and Europe divert more of their lumber resources to biofuels and as long as energy prices remain high, Canada’s lumber industry has a captive market for its residual waste. The BBC article estimates that oil would have to fall to $35 a barrel to compete with ethanol.

While there are ethanol, sugar and many other major commodity indices that capture biofuel stocks, the biofuels index provides an important global price benchmark to help reduce price risk in the growing international trade of biofuels. The next development will be a futures market in biofuels, in the same way that we trade futures on ethanol or blends of oil on commodity exchanges today. It’s all good. An increase in financial instruments available to manage volatile price risk in the biofuels market will result in an increase in the usage of carbon neutral commodities.

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