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In the previous blog, I argued that regulation can do something much more powerful than make an undesirable activity expensive. It can create demand for an alternative before that alternative would have won the market on its own. Biofuels are a particularly interesting place to watch this happen because this isn’t a hypothetical market waiting to emerge in 2035. Europe already consumes significant quantities of biodiesel, HVO, bioethanol and other renewable fuels, and entire supply chains exist to collect, process, certify and trade the feedstocks behind them.
What makes the market interesting is that it becomes rather difficult to understand the price of a biofuel by looking only at the physical commodity. A tonne of used cooking oil has physical utility, but its value also depends on what regulation allows somebody further down the chain to do with it. Two fuels capable of doing essentially the same physical job can have very different economic values because one helps a buyer satisfy a regulatory obligation and the other doesn’t.
This is where a commodity market starts becoming a regulatory market too.
Used cooking oil gives us a wonderfully strange economic object to work with. Somebody fries food in vegetable oil, the oil eventually reaches the end of its original useful life, a collector aggregates it, somebody processes it and eventually it can become biodiesel or HVO. Even without climate regulation, that waste can have a market because it still has physical utility.
European renewable-energy policy adds another layer of value. Under the Renewable Energy Directive, not all renewable fuels are treated identically. Feedstock, production pathway, lifecycle greenhouse-gas performance and sustainability characteristics can determine whether and how a fuel contributes towards renewable-energy obligations. Used cooking oil sits in Annex IX Part B of RED, and that classification affects its usefulness in the regulatory system.
Imagine two litres of fuel that can move the same truck the same distance. If one litre helps an obligated company meet a renewable-fuel requirement while the other doesn’t, those litres are no longer economically equivalent. The difference isn’t necessarily in what happens inside the engine; it is in what happens inside the buyer’s compliance calculation.
This is an important distinction because we sometimes describe green markets as though customers simply develop a preference for a sustainable product and voluntarily pay more for it. Parts of the biofuel market work quite differently. Regulation creates an obligation, that obligation creates demand for qualifying fuels and the resulting willingness to pay travels backwards through the supply chain, eventually affecting the value of the feedstock itself.
Suppose, purely illustratively, that fossil diesel costs €900 per tonne while UCOME costs €1,500. On ordinary commodity economics, nobody has much reason to volunteer for the extra €600. But if using the UCOME provides €700 of compliance value to a buyer, whether through meeting an obligation, avoiding a penalty or generating value within a national compliance system, paying €1,500 can suddenly make perfectly good economic sense. Regulation hasn’t made UCOME physically cheaper; it has changed what the product is worth to a particular buyer.
One of the reasons policymakers like genuine waste feedstocks is fairly intuitive. If additional demand for a crop-based biofuel causes more land to be brought into agricultural production, some of the climate benefit can be undermined by land-use change, competition with food production and emissions elsewhere in the system. Used cooking oil looks much more attractive because the restaurant wasn’t producing it in anticipation of Europe’s renewable-fuel targets. The oil had already served its original purpose and become waste, so using it as a fuel feedstock doesn’t necessarily create the same additional demand for agricultural land.
But the very thing that makes UCO attractive also makes its economics unusual. If it is genuinely a waste generated by another economic activity, its supply isn’t supposed to respond to biofuel prices in the same way that the supply of a deliberately produced commodity would. Higher prices can certainly improve collection, bring informal streams into formal supply chains and justify recovering material that was previously discarded, but there are still only so many restaurants, food factories and households generating genuine used cooking oil.
This is where the solar analogy from the previous blog starts becoming less useful. If demand for solar panels increases dramatically, manufacturers can build more factories and, over time, manufacturing scale and learning can reduce unit costs. If demand for UCO increases dramatically, we cannot simply build a factory that manufactures unlimited quantities of used cooking oil without rather defeating the definition. Beyond a point, additional demand is therefore more likely to make buyers compete harder for a constrained feedstock than to generate an equivalent increase in supply.
That creates a rather interesting policy paradox. Europe likes UCO partly because producing biofuel isn’t supposed to cause us to produce much more UCO in the first place. Regulation then gives that waste stream enough economic value that an entire market begins competing to find more of it.
The evolution of European biofuel policy makes more sense when viewed against this problem. The early attraction of biofuels was relatively straightforward: replace fossil fuels with renewable biological alternatives and transport emissions should fall. Reality turned out to be less cooperative because a biological feedstock is not automatically a low-carbon one.
Growing crops requires land, fertiliser, machinery and energy. Processing and transporting them requires more energy. Changing land use can release carbon, while diverting crops towards fuel can affect food and feed markets and potentially cause land-use changes somewhere else. European policy therefore became progressively more particular about what qualifies, introducing sustainability criteria, minimum lifecycle GHG savings, restrictions around food and feed crops and measures addressing indirect land-use change.
Waste and residue feedstocks became attractive partly because they could avoid some of these problems, but even here Europe eventually needed to distinguish between very different types of waste. Annex IX Part A broadly includes feedstocks and pathways that policy is particularly interested in developing, including various wastes, residues and lignocellulosic materials that can be harder to collect or convert. Part B contains used cooking oil and certain animal fats, where conversion pathways are relatively mature but sustainable feedstock supply is inherently limited.
I find that distinction economically more useful than simply memorising what sits in which annex. Part A is roughly an attempt to say, “we would like technologies and supply chains capable of using more of these materials to develop.” Part B is closer to recognising that “this is a useful waste resource, but there isn’t an unlimited pool of it on which to build the entire transport transition.” Policy is therefore doing more than identifying sustainable feedstocks; it is trying to influence which supply curves the market develops around.
The distinction between the physical commodity and its regulatory value becomes even clearer when we get to mechanisms commonly described as double counting. Under different iterations and national implementations of European renewable-fuel policy, certain qualifying waste and residue fuels have been able to make a greater contribution towards particular compliance obligations than their literal physical energy share.
Nothing magical happens to the fuel itself. One litre does not contain twice as much energy and the truck does not drive twice as far. The additional value exists in the regulatory accounting, which is precisely why it can affect what a buyer is willing to pay.
From a policy perspective, this is a way of favouring feedstocks considered environmentally preferable without simply subsidising every litre directly. From a market perspective, regulation has created another product characteristic with economic value. A trader therefore needs to know not only what the fuel is physically, but what it counts for in the particular market where it is being sold.
There is an important consequence here that can get lost when renewable targets are discussed only as percentages. A regulatory accounting contribution and a physical quantity of renewable energy are not always the same thing. The exact treatment varies across rules and national systems, but the broader economic point remains: once policy starts weighting different pathways differently, the regulatory identity of the commodity can become as important to its price as some of its physical specifications.
This is where I think discussions about green commodities become far too optimistic. Someone sees that European renewable-fuel obligations are increasing over the next decade and concludes that producing or trading biofuels must therefore be an attractive business. Mandated demand certainly changes the market, but it does not guarantee attractive margins for everyone participating in it.
Return to the illustrative example where fossil diesel costs €900 per tonne and UCOME costs €1,500. Suppose the buyer’s compliance economics mean that it is willing to pay only €450 above the fossil price, giving it an effective willingness to pay of €1,350. The seller still needs €1,500. The existence of a mandate does not magically close that €150 gap, and the fact that renewable-fuel demand is growing doesn’t mean a transaction has to happen on the seller’s preferred economics.
The buyer may be able to source another eligible pathway, change the timing of its purchases, use whatever flexibility exists in the relevant national system or simply wait for a better offer. The seller may decide another country values the same cargo more highly, hold the material, upgrade it into another fuel or sell to another sector. Meanwhile, everyone upstream knows that regulatory demand exists. Collectors can ask more for UCO, producers compete for feedstock, and logistics, processing, certification and financing all consume part of the regulatory premium.
The premium created by regulation therefore doesn’t arrive neatly in one participant’s bank account. It gets negotiated and fought over across the supply chain, which is why market growth and market profitability are two very different things.
This is where the Green Deal starts looking quite different from the perspective of a commodity trader. A compliance team may see an upcoming regulatory change primarily as something that creates another obligation. A trader can look at exactly the same information and ask what it will do to demand, supply and price.
Knowing that biofuel demand will rise is not particularly valuable if everybody else knows it too. The more interesting questions are which fuels will be needed, when the obligation actually begins affecting physical buying, which feedstocks qualify, what alternatives buyers have, which countries value particular characteristics most highly and where supply will struggle to respond when demand arrives.
The economic chain is fairly intuitive: a regulatory change creates future compliance demand, which eventually creates physical demand. Producers and supply chains respond, but they do not respond equally quickly everywhere. Somewhere in that process a bottleneck can emerge, and the bottleneck is often where the interesting price differential appears.
For one market the scarce thing may be UCO itself. Somewhere else it may be processing capacity, storage, airport blending infrastructure or access to a particular buyer. In an emerging market it could be a long-term offtake from a plant that has not yet been built. At another point it may simply be a cargo carrying exactly the feedstock classification, GHG characteristics and certification a buyer needs before the end of an obligation period.
This is still recognisably commodity trading. Traders source, finance, transport, store, blend, manage risk and find buyers. Regulation has simply added another set of specifications to the commodity, and those specifications can determine where the same physical material has the highest value.
There is, however, another side to making a waste characteristic valuable. If a fuel made from UCO receives better regulatory treatment than a fuel made from another feedstock, there is now an economic incentive to produce more genuine UCO, find more genuine UCO or, less desirably, claim that something is UCO when it isn’t.
The same logic applies elsewhere in the system. If a lower reported GHG intensity increases the value of a fuel, there is an incentive to report the lowest defensible number. If a particular origin or feedstock classification makes a product eligible for a valuable market, that classification matters financially. If the same sustainability characteristic can be claimed more than once, the compliance system can create more regulatory value on paper than the physical supply chain actually produced.
This is why evidence suddenly becomes important. Certification, chain of custody, sustainability declarations, GHG calculations and mass balance aren’t merely administrative accessories to the market. They are part of the infrastructure that allows these regulatory characteristics to carry economic value without the system immediately collapsing under false or duplicated claims.
But acknowledging that some evidence is necessary does not tell us how much evidence is optimal. Every additional control has a cost, just as every missing control creates a risk. If proving a €100 environmental characteristic costs €80 in audits, administration, reconciliation and systems, we should probably be interested in that ratio. The goal cannot sensibly be maximum evidence at any cost; it has to be enough confidence for the market to function without making the evidence architecture more expensive than the value it is protecting.
This is also why I think the next stage of sustainability regulation becomes much more interesting than annual reporting. Environmental characteristics are increasingly becoming attributes of products and transactions themselves. Feedstock, origin, carbon intensity, recycled content, certification and other information can determine what a product is worth, where it can be sold and what obligation it can satisfy.
At that point, two tonnes of material can look physically identical, perform the same function and still have very different economic values because of the information travelling with them. A tonne, increasingly, isn’t just a tonne anymore.
That is where I want to go next.
