Low carbon fuels drive vegetable oil price volatility
The availability of low carbon fuels, produced by a growing number of bio refineries, is increasing year-on-year. However, as supply rises, this is placing increasing constraints on the supply chains for both crop and advanced feedstocks, such as waste oils, animal fats, and greases. The supply of U.S. renewable diesel is expected to exceed six million tons per year in 2023 and may double by 2025, according to research from Barclays. Demand in the U.S. is playing catch up with supply, in part due to the faster penetration rates of alternative vehicles in California, including those fuelled by electricity and Renewable Natural Gas (RNG). California is the largest U.S. market for renewable diesel, accounting for 22% of all sales globally. The latest International Energy Agency (IEA) data shows biofuel demand will increase by an additional 41 billion litres per year over the period of 2021 to 2026. U.S. biofuel demand in 2026 is expected to reach 74 billion litres per year and around 29 billion litres per year in the European Union.
The demand for renewable diesel and other alternative transportation modes will further reduce demand for traditional fossil fuels, helping to meet ever more stringent carbon emission targets.
Chart 1: Soybean oil volatility increases
As a result, the veg oil markets are expected to remain important components of the biofuel supply chain and constantly changing market dynamics are likely to ensure that prices will remain volatile, providing additional liquidity into the CME Group futures and options benchmarks. Highly liquid markets typically generate higher trading volumes as more companies get drawn into the market to manage risk to reduce their exposure to large price swings (up or down) that can occur.
Veg oil volatility remains robust
In many cases, traders have turned to the futures and options market to manage price risk across the sector with products like soybean oil, palm oil, and rapeseed oil being the big beneficiaries of this trade. Trading volumes have responded to the increased demand resulting in higher traded volumes on exchanges such as CME Group. Average trading volumes in Soybean Oil futures were 2.5 million lots per month in the 12 months to September 2022. Palm oil volumes reached 23,000 lots per month in September 2022 year-to-date, a rise of 170% year-on-year, CME Group data shows.
Chart 2: Soybean Oil futures volumes remain robust
Soybean oil price relationship to palm oil strengthens
The trading relationship between soybean oil and palm oil has altered significantly in recent months, in part due to the ongoing U.S. demand for soybean oil but also the uncertainties around Indonesian exports of palm oil.
The U.S. demand for renewable diesel is supportive of the soybean oil trade and the U.S. Department of Agriculture estimates that demand for biofuel production, biodiesel plus renewable diesel, could account for 46.5% of total U.S. soybean oil production in 2022. The strength in soybean oil compared to palm oil is reflected in the futures market. CME Group data shows that the spread between the front-month Soybean Oil and Palm Oil futures contracts reached over $700 per metric ton in early September, up from $260 per metric ton, 12 months earlier.
Chart 3: Soybean oil to palm oil spread reaches multi-year high
The chase for feedstocks remains
The sourcing of feedstocks has become more challenging as the number of refineries producing renewable diesel has increased. Refineries are trying to source the same feedstock supplies, which is resulting in greater market volatility in prices. To try to alleviate the risk of potential shortages of supply, refiners have invested in new technologies to enable them to adapt their product slate and be able to process a wider range of feedstocks. Some of the second-generation feedstocks are currently considered niche by comparison to the existing crop-based alternative products and therefore are not as liquid on the traded markets.
In the U.S., soybean oil remains a key feedstock for renewable diesel and the strength of the soybean oil share of the soybean crush spread indicates the pull from the energy markets. CME Group futures data shows that the Soybean Oil futures share of the soybean crush margin reached over 50% in May 2022 and remains above 40% in early September 2022.
Whilst there are limits on the volume of crop-based feedstocks for biofuels in regions like Europe, demand is expected to remain strong for other products like waste and animal fats and greases.
Chart 4: Soybean oil share remains strong
U.S. and EU produce half of all biofuels
The U.S. and EU produced around 967,000 barrels of oil equivalent per day of biofuels in 2021, according to the latest edition of the BP Statistical Review of World Energy report for 2022. This represented around 55% of the global production volumes. By contrast, Asia produced 338,000 barrels of oil equivalent per day of biofuels over the same period.
In a drive towards lower carbon fuels, renewable diesel1 is expected to become a more significant portion of the biofuels segment. The IEA estimates that U.S. renewable diesel production in 2022 will reach 6.9 billion litres and Europe will produce 4.8 billion litres. Looking further ahead, Barclays forecasts a compounded annual growth rate in supply of around 15% to 2028.
The lower carbon footprint combined with the higher fuel quality of renewable diesel is expected to see demand rise in economies like the U.S. and EU. In some countries where biodiesel has become an established market, the demand for renewable diesel is expected to grow significantly. Part of the reason for this is that renewable diesel can be blended to much higher rates and it is also a superior quality fuel.
Renewable diesel is not subject to a blend wall where producers are required to blend biofuel feedstocks into biodiesel according to local regulations. In Europe, the blending rates are around 7% (B7) and can be up to 20% in the U.S. Higher blending quantities of renewable diesel are possible and market sources suggested that rates of up to 30% to 40% for some markets could be possible in the short-medium term. Other products, such as sustainable aviation fuel, are expected to become more widely available with blending targets announced across many countries for the first time. Argus Media2 expects 2.2 million tons could be available by 2025 in Europe and more than five million tons globally. Shell believes that 10% of global jet fuel sales could be sustainable by 2030.
The U.S. Energy Information Administration estimates a five-fold increase in renewable diesel capacity between 2020 and 2024, should all planned capacity additions come to market. By the end of 2024, U.S. refining capacity could reach 5.1 billion gallons per year or 330,000 barrels per day3.
Policy drives biofuel supply
Environmental regulations and tax incentives are encouraging the growth of more sustainable biofuels. The Low Carbon Fuel Standard (LCFS) is the cornerstone of U.S. environmental policy. Credits are traded between the producers of low carbon sustainable feedstocks and the producers who turn the feedstocks into biofuel products. Typically, the LCFS will help to support cleaner energy choices around feedstock supply with the more sustainable products yielding the highest blender credits. The LCFS has been a critical component in the further development of renewable diesel.
In Europe, the Renewable Energy Directive (RED II) is based on the greenhouse gas savings for each product. The latest policy, referred to as the “Fit for 55” package, aims to reduce overall greenhouse gas savings by 55% by 2030. Agriculture based feedstocks typically have lower greenhouse gas savings4 than the waste oils or animal fats where the greenhouse gas savings can reach over 80%.
As many countries strive to meet their net zero climate pledges by 2050 or earlier, further policies are expected to boost demand for more sustainable fuels. Biofuels, which are produced sustainably, look to set features more prominently in the market. Demand for waste-based feedstocks is likely to grow further especially in regions like Europe where countries are placing limits on the volumes of crop-based biofuels with the aim of boosting greenhouse gas savings. The changes are expected to be positive for products like renewable diesel.
As demand for renewable diesel picks up, the range of different feedstocks is expected to increase with crop, waste-based, and other advanced feedstocks picking up market share in the biofuel segment. Soybean oil remains an important product for the industry and is a large source of supply for the market compared to other more specialised feedstocks. The uncertain supply and demand balance outlook for this sector looks set to boost demand for risk management products. Therefore, the management of risk in what appears to be an increasingly volatile market through the trading of futures and options products like soybean oil and other products will be vital to the support of trading in these markets.
1 - Renewable diesel is the term used in the US and HVO is the equivalent term in Europe – article refers to renewable diesel
2 - https://www.argusmedia.com/en/news/2285785-viewpoint-hvo-saf-demand-to-outstrip-supply-in-2022
3 - July 2021 – EIA Today in Energy report https://www.eia.gov/todayinenergy/detail.php?id=48916#:~:text=As%20of%20the%20end%20of,day%20(b%2Fd).
4 - EU RED II – Annexe 5 GHG Savings https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32018L2001&from=EN
All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.
