In March 2022, the European Commission announced that the blending proportion of biofuels, as applied by member states, may be reduced so that less agricultural land is used for the production of biofuel feedstocks. It was clear by then that Russia’s unprovoked war in Ukraine would put pressure on the food and feed commodities markets.
The Latvian government was quick to seize this opportunity to make the blending of biofuels voluntary. However, the optional character of this obligation is an illusion and the intended short-term gains from this shift in regulation could eventually lead to long-term problems.
First of all, the government’s proposal has nothing to do with easing pressure on food markets. Instead, the move is intended to reduce fuel prices at the pump. Indeed, blended fuel is more expensive. However, the current hike in fuel prices is due to high oil prices, and abandoning blending obligations will not fix this – biofuel makes up just 6% of the fuel price, compared to the approximately 40% related to fossil fuels and 53% related to taxes and duties. Actually, the latter would be an obvious tool for the government in adjusting fuel prices swiftly. However, the government has already stated that taxes and duties should remain intact.
Secondly, agricultural land use is mostly linked to first-generation biofuels. The advanced biofuels specifically promoted by the Renewable Energy Directive have significantly less effect on the food and feed commodities markets. Accordingly, a better-tailored approach could have been considered by the government, e.g., a reduction of the blending proportion at the cost of first-generation biofuels only. This would not only exclude unproportionate restrictions with respect to advanced biofuels having no impact on land use but would also allow maintaining at least partial greenhouse gas emission reductions under the Fuel Quality Directive.
Ignoring those considerations can potentially lead to an increase in fuel price at the pump, distorted competition, and even greater backwardness in reaching the binding targets set for Latvia by the Renewable Energy Directive and the Fuel Quality Directive.
The mandatory blending obligations have been seasonal for many years already. In reliance on this well-established order, the necessary volumes of fuel, biofuel, or a blend have been contracted and significant volumes of blended fuel are already in stock, ready to be delivered to gas stations. The respective volumes could differ from one retailer to another. Thus, some retailers may be in a position to switch to an unblended (cheaper) fuel sooner than others, and the latter would have to choose between losing clients due to uncompetitive prices or incurring immediate losses by selling blended fuel at a discount.
In addition, the government’s proposal would increase the demand for fossil fuels in the regional market. Sanctions on Russia have already disrupted many supply chains, contributing to the recent price increase. The sudden increase in demand would drive fossil fuel prices even higher, and fuel could become more expensive at the fuel pump. Such a turn of events would leave the government with only one option – to reduce (at least, temporarily) fuel taxes and duties. But then the question is – why not do it now to avoid unnecessary turmoil?
The suspension of mandatory blending obligations could also increase fuel prices in the long run. The uncertainty created by the current decisions will likely force fuel traders to opt for short-term supply contracts, and that means more expensive fuel in comparison to that purchased under long-term agreements.
In 2020, Latvia was already well behind the 10% target for renewable energy in transport fuel consumption. The plan was to adopt the new Transport Energy Law, facilitating advanced biofuels and introducing a mass balancing system as a means to achieve biofuel targets. However, adoption of the law is significantly delayed, and the currently proposed suspension of the mandatory blending obligation will be yet another setback for environmental targets in transport. Moreover, at the end of the suspension, the respective targets will have to be reached in a shorter period, resulting in a noticeable fuel price hike.
It is obvious that the war in Ukraine has raised a number of issues for the Latvian government. The ever-increasing fuel and food prices must be addressed. However, attacking biofuels might not bring the expected relief and could create even more problems. Hopefully, the government will realize that it has more effective instruments to tackle those issues.
By Gatis Flinters, Partner, and Martins Tarlaps, Senior Associate, Cobalt