Biofuels Industrial Strategy of the Republic of South Africa

Department of Minerals and Energy

December 2007
Table of Contents Pages

1 Executive Summary ............................................................ 3

1 Introduction ......................................................................... 5
1.1 Purpose ------------------------------------------------------------------------------------------------- 5

1.2 Background -------------------------------------------------------------------------------------------- 5

2 Objectives of this Strategy................................................. 8

3 Feasibility Study Findings.................................................. 9

4 Current Situation ............................................................... 10

5 International Situation ...................................................... 11

6 Issues Involved ................................................................. 12

6.1 Agriculture ------------------------------------------------------------------------------------------- 13

6.2 Food Security --------------------------------------------------------------------------------------- 14

6.3 Animal Feed------------------------------------------------------------------------------------------ 15

6.4 Land issues ------------------------------------------------------------------------------------------ 15

6.5 Water Resources ----------------------------------------------------------------------------------- 16

6.6 Biofuels Production Plants --------------------------------------------------------------------- 17

6.7 Fuel Industry----------------------------------------------------------------------------------------- 17

6.8 Biofuels contracts --------------------------------------------------------------------------------- 18

6.9 Mandating Biofuels Uptake --------------------------------------------------------------------- 19

6.10 Integration ------------------------------------------------------------------------------------------- 20

7 The Strategy ...................................................................... 20

8 Specific Interventions ....................................................... 21

8.1 Licensing of Producers -------------------------------------------------------------------------- 21

8.2 Off-take by Petroleum Wholesalers Based on Discounting ------------------------- 22

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8.3 Fuel Levy Exemption ----------------------------------------------------------------------------- 22

8.4 Agricultural Support ------------------------------------------------------------------------------ 23

8.5 Capacity Building and Development -------------------------------------------------------- 23

8.6 Government Agencies---------------------------------------------------------------------------- 23

9 Other................................................................................... 24
9.1 SADC Integration----------------------------------------------------------------------------------- 24

9.2 Future Research and Development ---------------------------------------------------------- 25

10 Implementation Plans ....................................................... 25

10.1 Communication and Education --------------------------------------------------------------- 26

10.2 Monitoring and Evaluation---------------------------------------------------------------------- 26

10.3 The Way Forward ---------------------------------------------------------------------------------- 26

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 BIOFUELS INDUSTRIAL STRATEGY

1 Executive Summary

This document presents the proposed South African Biofuels Industrial Strategy and outlines
Government’s approach to policy, regulations and incentives. This is a refinement of the draft
Strategy approved by Cabinet for public comments in December 2006. The changes are based
on comments received from a wide range of stakeholders. The stakeholders’ comments
covered areas such as water limitations, food security (availability and affordability), land
prices and land restitution, environmental concerns, biofuels quality, technology choices, crop
selection/choices, support and incentives and concerns that strategy/policy is taking too long to
be finalized.

The draft Strategy was developed by the Biofuels Task Team appointed by Cabinet in
December 2005 with a mandate to develop a national Biofuels Industrial Strategy targeted at
creating jobs in the energy-crop and biofuels value chain, and to act as a bridge between the
first and second economy.

A significant change to the draft Strategy is to adopt a short term focus (5 year pilot) to achieve
a 2% penetration level of biofuels in the national liquid fuel supply, or 400 million litres pa. The
target has been revised down from the 4.5% target that was initially proposed in the draft
Strategy document. The following crops are proposed for the production of biofuels in the
country: for Bioethanol, sugar cane and sugar beet and for Biodiesel sunflower, canola and
soya beans. The exclusion of other crops and plants such as maize and Jatropha is based on
the food security concerns. Further research is still needed to test usability of these in the
country.

The 2% level can be achieved without jeopardising food security. The strategy targets new and
additional land and proposes that basic food crops be excluded in the initial stages. This will
require about 1.4% of arable land in South Africa. Currently 14% of arable land, mainly in the
former homelands, is under utilised. The producer (investor) incentive should only be allocated
to projects that involve expansion that assist in achieving the 2% target. This will ensure job

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creation, expanded agricultural production, and increased food supply. In the case of extreme
drought and crop failures, a certain percentage of feedstock on the additional agricultural land
may be redirected to the food market to address shortages. In terms of the first and second
economy trajectory, government will have to support the development of the under utilised land
to a level that will compete commercially. Farmers located in underdeveloped land will be
encouraged through cooperatives (where possible) to participate in the running of biofuels
refineries.

The existing fuel levy exemption, for biodiesel that is a product (as opposed to producer)
incentive should continue.
Biodiesel currently enjoys a 40% fuel levy exemption. It is proposed that once the
Strategy is approved, this levy exemption be increased to 50% from the 2008/9
financial year. Thereafter the percentage will remain the same but the absolute value
of the support will increase with increases in the fuel levy. It is impractical to
increase the exemption beyond 50% due to the impact of the current diesel tax
refund scheme.

A 100% fuel tax exemption is proposed for bioethanol as it can also be used in
markets other than petrol e.g. ethanol gel that competes with illuminating paraffin.
Illuminating paraffin carries no levies.

The producer support mechanism will be used to balance the difference in fuel tax support to
bioethanol and biodiesel by setting a fixed margin price. A 100% petrol tax exemption amounts
to an effective support of R1.21 per litre, whereas a 50% diesel fuel levy exemption amounts to
an effective support of R0.53 per litre. The support to bioethanol as a product is thus 68 cents
per litre higher than diesel. The proposed support during the initial stages should assist
investors to achieve a reasonable return on investments.

To reduce project risk related to feedstock provision, further support to the farmers and
particularly communities living on the under utilised land, will be needed. This can be done
through existing agricultural support programmes as well as from support of investments made
by the project in agricultural development.

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1 Introduction

1.1 Purpose

Internationally, the growth of the biofuels industry has been driven by a number of factors
which includes: the support for renewable energy, support for cleaner and environmentally
friendly energy sources in a bid to limit global warming; upliftment of the agricultural sector
(through utilisation of surplus agricultural land to produce products in excess of food needs);
promotion of sustainable development, exertion of downward pressure on global crude oil
prices and the need to improve energy security. The biofuels programme has the potential to
uplift agricultural sectors and to unlock substantial economic benefits in sub-Saharan Africa,
South America and other developing regions, in particular by:
o Attracting investment into rural areas;
o Promoting agricultural development;
o Import substitution of foreign oil with balance of payment savings; and
o Overcoming the trade distorting effects that South Africa, African subcontinent and other
developing countries have faced overtime because of subsidised agricultural production
in developed countries.

In South Africa, a specific requirement of the Biofuels Industrial Strategy was to create a link
between the first and second economies. This requirement entailed creating jobs in under-
developed areas, such as in the former homelands, where agriculture was undermined by the
apartheid system.

Clear government policy regulations and incentives are a pre-requisite for the development of
the biofuels industry. This is particularly due to the volatile nature of oil product prices with
which biofuels must compete; this is a similar scenario to that experienced by South Africa
during the development of the synthetic fuel industry.

1.2 Background

This section traces chronologically the development of Government policy on energy (including
renewable energy and biofuels) and sustainable development that gave impetus for the
development of a biofuels industry in the country.

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 o 1998 – The White Paper on Energy Policy set the country’s energy policy and
acknowledged the importance of alternate transport fuels and a diversified energy
supply mix.

o May 2001 – Department of Arts, Culture, Science and Technology completed a

Technology Audit of the Transport Fuels Sector, which concluded that the largest
energy saving potential lies in improving vehicle efficiencies; that biofuels need more
investigation; and that the level of government support should be determined.

o 2002 – South Africa hosted the World Summit on Sustainable Development (WSSD).
The outcome of the WSSD was the Johannesburg Plan of Implementation (JPoI), which
commits South Africa to developing renewable energy technologies, including biofuels.

o 2003 – The White Paper on Renewable Energy sets a renewable-energy target of

10 000 GWh (equivalent to 0.8 Mtoe) to be achieved by 2013. In South Africa, transport
fuels make up 30% of energy consumption (by energy content) and 70% (by value).
Therefore the transport sector is an important energy sector to consider the
development of renewable energy sources and technologies.

o 2003 – The Petroleum Products Amendment Act, (Act No. 58 of 2004), authorises the
Minister of Minerals and Energy to require licensed liquid fuel wholesalers and
producers to supply and sell petroleum products made from “vegetable matter”. This is
an important legislative vehicle for the biofuels development in the country.

o 16 February 2005 – The United Nations Framework Convention on Climate Change

(UNFCCC) and its related Kyoto Protocol comes into effect. The Kyoto Protocol obliges
industrialised countries (known as “Annex 1 countries”) to reduce their greenhouse gas
emissions by at least 5% compared to 1990 levels over 2008 to 2012, primarily by
investing in cleaner technologies in developing countries. South Africa acceded to the
Kyoto Protocol in March 2002. Although the Kyoto Protocol does not commit the non-
Annex 1 countries (like South Africa) to any quantifiable emission targets, there is
potential for future, low-cost emission reduction options in these countries. The Clean
Development Mechanism (CDM) provides for trade in certified emission reductions

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 (CERs) between non-Annex 1 countries and Annex 1 countries and thus supports
sustainable development with respect to greenhouse-gas emissions reduction in
developing countries. At the same time it helps Annex 1 countries to comply with their
Kyoto Protocol commitments. Biofuels projects may apply for carbon emission reduction
credits via mechanisms such as fuel switching.
.
o 2005 – The National Treasury approved the increase of the Fuel Levy exemption for
biodiesel from 30% to 40%. The exemption was introduced in 2003. SARS allows for
100% exemption for small biodiesel producers (less than 300 m3 annually). Biofuels
investments also qualify for a tax-depreciation write-off of 50:30:20 percent over three
years. This equates to support of about 10 cpl.

o 2005 - A Department of Science and Technology (DST) led Bio-diesel Joint

Implementation Committee conducted a detailed examination and concluded that
government supported biodiesel production can be justified due to its environmental and
socio-economic benefits.

o July 2005 – The National Treasury released a Discussion Paper on Environmental

Taxes, which proposed an extension of the fuel levy exemption incentive to bioethanol,
and that the basis for incentives should be linked to external benefits.

o September 2005 – The National Treasury approved a Renewable Energy Capital

Subsidy Scheme administered by the DME. In 2006/7. The Subsidy provides for 16.7 c/l
subsidy for bioethanol and 27.3 c/l for biodiesel, up to a maximum of R20 million.
However, cost competitive world scale projects typically require an investment in the
order of R1 billion. Effectively this proposed support amounts to 2% of the required
investments.

o 2006 – The DST supported the South African Bureau of Standards to develop the
required analytical and technical capacity to perform bio-fuels analysis.

o 2006 – The Cleaner Fuels Programme phased-out leaded petrol and reduced sulphur in
diesel to a maximum of 0,05% (mass). Regulations gazetted under the Petroleum
Products Amendment Act in June 2006 in support of this programme included a specific

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 allowance for biodiesel addition and mandates fuel specifications according to South
African National Standards (SANS). SANS has finalised specifications for biodiesel and
fuel ethanol, and is developing a standard for ethanol gel fuel. The standards are in line
with European, United States of America and Japanese standards. These countries
were selected because the automotive industry is dominated by manufacturers from
these markets. The revision of standards and their deployment fits in with the measures
proposed in this document, which will enhance the development of cleaner fuels into the
South African petroleum pool.

o November 2006 –A draft National Biofuels Strategy submitted to Cabinet, was

subsequently issued for public comment until May 2007. This document reflects the
changes made to the draft Strategy based on the Biofuels Task Team’s analysis of
stakeholder comments and inputs.

2 Objectives of this Strategy

The National Biofuels Industrial Strategy is driven predominantly by the need to address issues
of poverty and economic development. The focus of the Strategy, therefore, will be the
promotion of farming in areas previously neglected by the apartheid system and areas that did
not have market access for their produce. Most of these areas are in the former homelands.
The strategy is also aimed at creating a development balance between previously
disadvantaged farming areas and commercial farming areas. This will ensure the sustainable
development of the biofuels industry as it looks both at creating commercial agricultural areas
and providing firm opportunities for new and emerging farmers. The Strategy seeks to
stimulate rural development and to reduce poverty by creating sustainable income-earning
opportunities. Biofuels plant investment can be a catalyst for the transformation of rural
economies and contribute to the government’s Accelerated and Shared Growth Initiative
(AsgiSA).

Furthermore, biofuels can also contribute towards the achievement of the renewable energy
goals; energy security and the reduction of greenhouse gas emissions. The feasibility study
underpinning this strategy included an analysis that considered the impact of all these factors.

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Biofuels industry will support a variety of national priorities, including job creation, sustainable
development and Black Economic Empowerment, thus prioritising these benefits in the
Strategy enabling regulations and incentives to be optimised.

3 Feasibility Study Findings

The extent of Government support and the location of the biofuels plants will determine the
ultimate size of the biofuels industry. Government support must be justified by maximising
benefits and minimising costs and unintended consequences. As part of the feasibility study, a
comprehensive and integrated model was developed to determine likely and optimum
scenarios. From these scenarios, benefits, costs and risks were identified.

Biofuels supply requires low-cost, high-yield and surplus agricultural production, generally not
destined for food consumption, as well as government support, particularly when crude oil
prices are low. South Africa has limited arable land, only 14% of the total land available. About
10% of this land is irrigated, consuming 60% of the national water supply. However, in most
years South Africa has surplus crop production, each of which could generate sufficient
ethanol to meet 5% of national petrol demand. In addition, there are 3 million hectares of under
utilised, high potential land, mainly in the former homelands. Utilising 1 mil ha of such land
could produce biofuels representing about 5% of national diesel usage.

The feasibility study determined that production would vary regionally according to climate and
soil characteristics and that co-product markets would limit biofuels capacity and affect costs.
An achievable production level from surplus crops and under utilised land equates to 4.5% of
national petrol and diesel volumes.

The proposed initial 2% biofuels penetration that will have a producer support scheme requires
the use of local crops grown mainly on currently under utilised land in the former homelands
and support from the commercial land. The 2% biofuels scenario will create 25 000 jobs. The
capital spend per job created is about 65% less than the Industrial Development Corporation
target. This will reduce unemployment by 0,6% (mainly in rural areas); boost economic growth
by 0.05% (or 2.5% of the AsgiSA target increase); achieve a balance of payments saving of
R1.7 billion; and a greenhouse gas emissions’ saving of R 100 million per annum. To reach

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this percentage for biofuels penetration, will require investments of about R4 billion over the 5
year period. The creation of this new industry would require a favourable investment climate.
The jobs-to-investment ratio is about 100 times higher than for crude oil refineries. South
African motorists and consumers have in the past supported the investment and operation of
oil refining. In addition they have ensured the viability of the synthetic fuels industry by
sheltering it from low oil prices, specifically incorporating a reasonable return on capital support
scheme for fuel wholesaling that produces minimal jobs, forex savings, economic growth and
environmental benefits.

4 Current Situation
South Africa used bioethanol from sugar cane in petrol from the 1920’s until the 1960’s, when
this fell away due to low international crude oil prices. Recent high oil prices and climate
change considerations have led to major national and international interest in investing in
biofuels production again.

A number of potential investors have expressed interest in biofuels development. Some sugar
industry players are already producing bioethanol for the potable and export alcohol markets
and are developing fuel ethanol capacity in neighbouring countries. Some maize growers, in
collaboration with private investors, have announced their intention to build several maize-to-
ethanol factories. This has faltered due to uncertainty over regulations and incentives and due
to the significant increase in local and world maize prices. The maize price increase has
occurred largely due to the USA, which produces about 50% of world traded maize, diverting
25% of its crop to ethanol production, as well as to the phasing down of agricultural export
support. Similarly, world oilseed and oil prices have increased significantly due to higher oil
prices coupled with bio-diesel demand and incentives in many developed nations, particularly
in the USA and the EU. Many foreign companies have examined biodiesel production as part
of their arms deal offset obligations. The global maize price increases and the shortage of
basic food stuffs in Mexico, which were directly linked to biofuels investments, has influenced
South Africa to exclude maize use in its initial stages of biofuels development.

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5 International Situation

The demand for biofuels internationally is being spurred on by higher oil prices and
government targets (mandates) and incentives. The leading ethanol producers are Brazil and
the USA. Brazil has been producing ethanol from sugar cane since the 1970’s. It meets about
20% of their liquid fuel demand; Brazil’s national ethanol consumption is about 1.5 times higher
than South Africa’s demand. Brazil is increasing capacity and aims to achieve a 50% ethanol
contribution to liquid fuels supply. They are working on a Biodiesel programme. For Brazil,
ethanol production is viable at an oil price of $45/bbl. However, this includes a renewable
electricity co-generation incentive of about $10/bbl from sugar bagasse. In addition, electricity
costs are significantly higher than South Africa’s, and this equates to an effective support of a
further $10/bbl. To put South African ethanol producers on the same footing would require a
$20/bbl higher oil price than applies in Brazil, or about $65/bbl. In this case, $20/bbl roughly
equates to SA 100 cpl support to ethanol.

The Brazilian experience indicates that the renewable energy benefit will be derived from the
ethanol and electricity produced from sugar bagasse. The sugar based Bioethanol production
industry has a positive energy balance, as it generates its own energy needs without an
additional burden on the national grid. The USA produces ethanol from maize supported by
incentives of up to R2 per litre (ca $40/bbl). The EU recently reached a 2005 biofuels target of
2% of road transport fuel usage and has set a target of 5.75% by 2010 on the back of fuel levy
exemptions amounting to $80/bbl (SA 400 cpl). The energy balance of generating Bioethanol
from maize is negative, because this industry does not generate its own energy.

Contrasted with South Africa, it is important to note that Brazil has abundant agricultural
potential and in the USA farmers get huge subsidies and the feedstock used is not a staple
food crop.

The success of biofuels varies from country to country and largely depends on government
support. However, long term investments and increased efficiency have proved important in
Brazil’s case. Germany, the largest user of biodiesel, is now reducing its incentives, to cut
losses to the fiscus, and is moving to a mandatory target. This approach has problems as fuel
off-takers will only buy until the annual mandate is reached. If mandates are fulfilled early in
the year, then any additional biofuels produce could lose the market.

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Comparative analysis of international experience shows that the biofuels industry particularly
as an infant industry is at the mercy of volatile oil prices, crop prices and exchange rates. It
therefore requires government support in the initial stages.

6 Issues Involved
The Biofuels Industrial Strategy is premised on the development of partnerships along the
value chain and across the affected sectors. Firstly, the Strategy envisages the creation of a
reliable market for fuels from biological sources and the fuels market. Biofuels can be used as
blending components in both petrol and diesel production. The proposed blending ratio for
South Africa is B2 or 2% biodiesel and E8 or 8% Bioethanol blend. In the case of petrol, bio-
ethanol can substitute a number of octane boosters currently used by the oil industry and
biodiesel can be used by the synthetic fuels producers and other producers as a blending
stock.

Secondly, the Strategy is premised on the pegging of the sales price of bio-ethanol and
biodiesel as blending components at a price that covers the costs associated with running a
biofuels plant1, agricultural feedstock and of transportation. It is expected that farmers
supplying the biofuels plant with feedstock, particularly emerging farmers, could organise
themselves into co-operatives to maximise benefits and market power and also participate
either fully or partially in the ownership of the biofuels plants. The Strategy with its focus on
rural development envisages that contracts will be signed between farmers’ cooperatives and
individual biofuels producers. This is currently done in the sugar Industry. The contracts will
facilitate sourcing of funding from relevant funding institutions such as the Land Bank and
guarantee feedstock supply for the duration of the contract.

Thirdly, it is expected that the cost of biofuels will be ring-fenced, and remunerated separately.
This is because biofuels will be blended at wholesale level. The cost to the motorist will be
equivalent to $65/bbl of crude oil based refined products and therefore will present a benefit,
although limited to only 2% if the price of crude oil stays above $65/bbl.

1
The costs will include an allowance for a return on the installed capital commensurate with the risk. This return
will be determined in the same way as the revised margin setting approach used to set petroleum products
wholesale margins. The margin will be fixed for a period but reviewed regularly as per an agreed formula.

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Fourthly, and perhaps most importantly, the mandate for the development of the biofuels
industry was clear, namely: “Bio-Fuels are a key driver in AsgiSA, for socio- economic
development. Cabinet, on 7 December 2005, approved the development of an industrial
strategy targeted at creating jobs in the energy crops with the bio-fuels value chain, acting
as a bridge from the second economy to first economy status.” It is in this regard that
development of the industry based on imported feedstock has not been supported. This can
only be supported at times of adverse agricultural production and when local producers cannot
meet the investors demand.

Lastly, the Strategy targets areas of South Africa that are worst hit by poverty and deprivation.
It hopes to generate economic activity, mainly, in the former homelands. Furthermore, only
agricultural products grown in the previous homelands by historically disadvantaged farmers
will qualify for the support. Only biofuels plants that have been identified to assist in achieving
the initial target will be supported and their location will be a condition of the issuing of a
manufacturing licence. The plants will be located throughout the country depending on the
investor’s choices and also as per the conditions of licences.

6.1 Agriculture

Biofuels development in South Africa is about rural development and the provision of
opportunities to the rural poor by creating a market for their produce that would otherwise not
exist.

In addition to the international oil price, which largely determines biofuels prices, the viability of
the biofuels industry is largely a function of the cost of agricultural feedstock, typically 70% of
total costs. Operating costs and capital payback are each about 15%. The specific projects
and their associated crops will be determined by factors such as land availability and
productivity and the agricultural products market. The biofuels industry impacts positively on
the agricultural value chain providing better off-take or demand security, which can also
stimulate better land productivity.

Internationally, biofuels production is used to support local farmers, and European biofuels
production requires massive subsidies to match existing agricultural subsidies. In South Africa,
this is not envisaged because apart from sugar cane, which has a floor price, agricultural

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subsidies are limited. Thus the support to develop feedstock supply will be achieved by
targeting existing agricultural support programmes such as Comprehensive Agricultural
Support Programme (CASP) of the Department of Agriculture (DoA) to assist biofuels
investments by increasing production. CASP will prioritize those aspects of production that will
enhance effective cropping for biofuels. The budget for CASP is increasing steadily, which
over time will enable more farmers to be involved. If under utilised areas are prioritised for
feedstock production, then CASP will be in line to enhance that priority. Other sources of
support from provincial departments of agriculture will be supplemented by CASP.

One of the objectives of the grain strategy is to address the drop in the production areas based
on availability of markets. It has identified as a challenge the dropping of prices due to the
increase in supply not met by the demand. This leads most farmers to produce less, with much
agricultural land left lying fallow. The grain strategy, therefore, will assist in food security
challenges that might be brought about by the development of Biofuels Industry nationally and
internationally.

6.2 Food Security

The development of a modest biofuels sector, which targets under utilised land in former
homelands, should have a minimal impact on both food security and prices. Currently 14% of
arable land is under utilised, and most of it is in the former homelands. These areas lack
market access which biofuels plants will provide and infrastructure that agricultural and
infrastructural support programmes should provide. Specifically the 2% level of biofuels
proposed for support for the incubation phase will not compromise existing food markets, as
this target can be achieved with about 300 000 ha of land or about 1.4% of national arable
land.

The main concern regarding food security revolves around the use of maize for ethanol
production. It is for this reason that it has been proposed that maize for the production of bio-
ethanol should be excluded in the initial phases of the strategy implementation. It is envisaged
that bio-ethanol production from maize will be considered only once certainty on the ability of
the currently under utilised land to produce has been ascertained and the necessary measures
are in place to guard against extreme (industry linked) food inflation. It is, however, believed
that almost all of the previous productive land in the homelands can be brought into full

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production once a firm market for the produce has been secured. To specifically ensure the
use of under utilised land from the former homelands, a fixed margin scheme will only apply to
litres produced from feedstock grown on this under utilised land.

6.3 Animal Feed

Biofuels production will also contribute to food security by increasing the availability of by-
products that can be used for animal feed. These include protein oilcake, from biodiesel
production from sources such as soya beans, which are currently being imported. Concerns
have been raised that biofuels production could lead to an oversupply of these by-products.
The analysis undertaken during the development of the Strategy showed that this would not be
the case for biofuels production of up to 4.5%. Therefore the 2% incubation level proposed on
this revised Strategy will also not have any impact. Distillers Dried Grains and Soluble
(DDGSs) will be absorbed into the animal feed without any major expansion in the livestock
industry. This fact has been confirmed by the animal feed industry during the stakeholder
consultation process. The animal feed will provide important additional income streams for
biofuels plants.

The concern about animal feed is premised on the South African livestock industry remaining
static and, in particular, there not being an expansion of the feedlot industry. Such expansion is
already taking place, for example under the Livestock Beneficiation Programme of the North
West province. The expansion will increase the demand for animal feed and increase the
supply of cheaper meat and dairy products in the country.

6.4 Land issues

In the consultation process community members expressed concern that the price of land
might be high as a result of biofuels production. They indicated too that they had been
approached by potential developers willing to buy their land. The production of biofuels can
contribute to the objectives of the Land Reform and Restitution programmes by providing
sustainable market access for farmers who benefit from these programmes, particularly on
development projects run by state-owned enterprises. Thus the biofuels industry can enhance
rural development and economic activities for black landowners. In addition, meeting the 2%

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biofuels target will require only about 1.4% of national arable land, which is not a significant
percentage given that nearly 14% is currently under utilised.

6.5 Water Resources

The impact of biofuels production on water resources was raised as an important concern
during the consultation process. DWAF has noted that much of the country is water stressed
and that there are severe limitations on the availability of additional water for allocation to new
uses. Irrigated agriculture already uses about 60% of the total available resource. Irrigated
cropping for biofuels will have to find its water from existing allocations, or compete for scarce
new water. The most important threat to water, therefore, lies in competition with other uses.

Dryland crops such as soya and maize are not listed as water users. Nor is dryland sugar
cane, although this crop is recognised as an activity which can have a significant impact on
stream flow, and thus availability to other users. Where dryland crops are found to have an
undue impact on other users, these will have to be regulated, much as the forestry industry is
currently controlled today.

DWAF has also noted that Water Allocation Reform is an important strategy within the
Department, and that biofuels feedstock production could take up water made available
through this programme.

Certain new dryland crops for biodiesel, such as Jatropha curcas and Moringa oliefera, could
impact on water resources, competing for both land and water with the forestry sector. The
research undertaken through the Water Research Commission does not show Jatropha to be
a major water consumer but expansion into new crops will have to be monitored.

DWAF notes that impacts on water quality (erosion and siltation, and fertiliser and pesticide
runoff) are as important a concern as impacts on available volumes, and that best practice
management for both land and water will have to be applied to all biofuels cropping, both
irrigated and dryland.

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6.6 Biofuels Production Plants
The conventional technology to produce biofuels is well established, and production processes
are mature, even in South Africa. More efficient technologies i.e. second-generation
technologies, which are not dependent on food crops, are being developed and South Africa
should keep abreast of these developments by investing in research and development. This
will be facilitated by the existence of an initial domestic biofuels industry. The 2% that will be
supported by a fixed margin scheme will only apply to proven commercial processes and
agricultural feedstocks. The selected main crops for biofuels development in South Africa are
soya, canola, and sunflower for biodiesel and sugar cane and sugar beet for bio-ethanol.

The biofuels industry needs to support government development priorities and provide
investors, both the investors in refining plants and farmers, with a reasonable return on capital,
stemming from a security of demand and an acceptable margin between the fuel-based
biofuels price and the agricultural feedstock input cost. If the biofuels industry is to achieve the
expected level, Government needs to facilitate an environment conducive to investment and
the broader participation of previously disadvantaged citizens. Such support must not be
excessive (i.e. too costly to the state and public) and should not jeopardise food security. The
long-term intention is to reduce support once the industry is established. In other words, once
capital has been paid back, efficiencies have improved and entry barriers and costs have been
reduced. The 2% biofuels target includes a reasonable return that will only apply up to 2020 for
approved projects and litres, and will enable debt to be repaid.

Licensing requirements will need to be streamlined to ensure biofuels development remains

sustainable and is not delayed. However, all developers will have to comply with the required
legal and regulatory frameworks.

6.7 Fuel Industry

Internationally, the oil industry is becoming more active in the development of biofuels and is
accepting biofuels products, often driven by mandated upliftment. This involvement allows for
the better management of biofuels in the conventional fuel-supply chain. This is already done
in countries such as Brazil, USA and European countries where biofuels development is
supported by the government. The draft Strategy supported the use of existing oil industry
infrastructure to accommodate biofuels efficiently and allow biofuels to be regulated under
existing oil industry regulations. The specifics of biofuels uptake still need to be negotiated with

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the oil industry to maximise efficiencies, reduce costs, and ensure that the fuels are fit for the
intended purpose.

In the production of petroleum products a number of blending components are used. The
introduction of 2006 fuels specification resulted in an increased import of octane boosting
components because almost all refineries in South Africa, at varying degrees, are octane
short. The 2006 fuels specifications also resulted in lower sulphur in diesel, which raised
concerns with lubricity (lubrication) of low sulphur diesel. Introduction of biofuels into other
liquid fuels will go a long way in addressing some of these concerns. Biofuels, however, bring
an added advantage in that they are locally produced and therefore Rand based which
presents “hedging” potential for the motorist. It is for this reason that it has been deemed
beneficial to all that a fixed price2 contract be offered to biofuels producers, in return for
reduced crude oil price risk3.

6.8 Biofuels contracts

The agricultural sector has a number of active market instruments because agricultural
products are generally sold on forward contract basis. Farmers generally sell 80% of their
produce on contract for delivery at the end of the planting season, leaving only about 20% for
sale on the spot. Like in all markets, the contracts are themselves traded, making the
secondary and tertiary market the biggest market. Trade in these derivatives is up to 12 times
that of the trade in the physical commodity. Although some farmers would sell some of the
produce at spot prices, for them to access funding, they would have to enter into a fixed term
contract with milling companies, etc. Without such contracts, farmers cannot get funding to
grow and harvest their produce. The failure of homeland farmers is largely attributed to a lack
of market for their produce.

The core of the biofuels strategy is the contract to be signed between oil companies and
biofuels producers. The details of the proposed contract will be finalised during the
development of the implementation plan but in essence biofuels will be bought at a price that

2
The price will be adjusted on a regular basis in the same manner as for all fuel price components.
3
The level of price risk cover is limited to 2% of fuel pool. Even if the crude price was to fall below the current
level, exposure is limited to 2% of fuel pool. The likelihood, however, is that the price of crude will rise and
therefore motorists, in the long run, should benefit more from the transaction.

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will ensure long term viability of both biofuels refining and feedstock growing processes. The
contract will come with an obligation to supply approved crops grown only in designated areas
and with a guarantee that the said crops will be bought at a given price, regardless of the price
of crude oil. The price at which biofuels producing plants buy crops will have to be on par with
that paid to producers for the food sector. If the price was to be different, it would create
arbitrage opportunities for speculators: buying crops destined for one sector for sale to
another. The idea is not to create a different contract for the biofuels sector. A fixed margin will
then be added to the cost of acquisition of feedstock to cover transport and refining costs.

The contracting mechanism will work along the following principles: Oil companies will enter
into a contract with biofuels producers and buy biofuels as a blending stock at the agreed
price. As per estimated production for a period, monies will be collected from the petrol pump
to cover the sale and paid to a dedicated “slate account”. Oil companies will then submit claims
against the slate account. To ensure that the system functions properly, however, payment will
only be made to a contracting oil company upon receipt of proof of sale from biofuels
producers to the contracting oil company.

6.9 Mandating Biofuels Uptake

Mandatory off-take can be introduced only when security of biofuels supply can be guaranteed.
However, the different biofuels manufacturers will enter into supply and off take agreements
with the individual oil companies. The oil company will in turn claim the amount bought from a
dedicated slate, and in turn these costs will be passed on to the motorists on a straight cost
recovery basis, based on the agreed rate in cents per litre.

The option of enforcing or mandating biofuels uptake in the initial phase is not favoured.
Rather biofuels producers should be enabled to reduce prices, enabling parties supplied by the
oil companies to purchase directly from biofuels producers. However, the mandating of
biofuels can be done through the Petroleum Products Amendment Act, which gives the
Minister the powers to do this. It is further proposed that petrol containing bio-ethanol should
retail at a deregulated price and this should be done to facilitate off-take. In this way price
deregulation is proposed for biofuels. Such deregulation will also contribute to oil industry
liberalisation and support new BEE wholesaler entrants.

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6.10 Integration

The biofuels industry provides an opportunity to link the second economy with the developed
first economy as it is agriculturally-based, requires low levels of technology and is employment
intensive. The first economy is a major user of liquid transportation fuels. The integration of the
value chain needs clearly defined partnerships. Specifically, the producer incentive scheme
should be limited to litres produced using agricultural feedstock supplied from currently under
utilised land in the former homelands.

7 The Strategy

Government intervention and regulation should be considered, but minimised, and incentives
should decrease over time. Regulation may be needed where there are market failures.

Following comments and inputs from the broader stakeholder groups the BTT, in addressing
these comments, particularly around food security, environmental concerns, land concerns,
benefits for small farmers and quality control, has revised the initial target of 4.5% as proposed
in the draft Strategy to a 2% target in the initial development stages. The Biofuels Strategy
initially aims to develop the biofuels industry to achieve a market penetration of 2% of road
liquid transport fuels. This would contribute 30% to the national Renewable Energy target for
2013. In terms of the liquid fuels, it represents about 30% of national energy consumption. This
is to be based on local agricultural and manufacturing production. Imports are limited to ensure
increased use of the local produce and local economic development, and in consideration of
the biofuels strategy objectives such as job creation, bridging the gap between 1st and 2nd
economies and promotion of BEEs.

The driver to achieve 2% biofuels investment is an incentive dispensation. The incentive

scheme best suited to this is one that ensures biofuels investors and farmers a reasonable
return on assets commensurate to risk.

For bio-ethanol, assuming a 100% fuel levy exemption, the support price was determined as
R4.20 per litre ($65 per barrel crude oil equivalent), whereas for biodiesel, assuming a 50%
fuel levy exemption, a supportive price on an equitable basis would be R4.88/litre (about $80

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per barrel crude oil equivalent).The proposed incentive hedges biofuels producers and fuel
consumers against low and high oil prices respectively. The costs of the incentive entail:

The fuel levy reduction that at 50% equates to R15 000 per job. With justification,
this rebate could be raised to 100%, or roughly R30 000 per job, which will still be
competitive when compared to the cost of jobs for fuel retail site attendants. World
Trade Organisation (WTO) rules allow for 100% fuel levy reductions for biofuels. A
100% reduction, given the relatively low South African fuel levy, would cost the
fiscus less than 3 cpl on overall fuel levy income.

The cost of forecourt attendants’ jobs built into the petrol price is 8.9 cents per litre
for about double the number of jobs. Thus, just as self-service at petrol stations are
prohibited to protect jobs, so too should biofuels receive some similar level of
protection to ensure job creation. Biofuels have added environmental and balance of
payment benefits.

The biofuels industry strategy further recommends that the following blending levels be
achieved: for Biodiesel B2 or 2% blending requirement and for Bioethanol E8 or 8% blending
requirement. For the initial investments and development of biofuels in the country, the
following crops will be used for the production: for Bioethanol sugar cane and sugar beet and
Biodiesel soya bean, canola and sunflower.

8 Specific Interventions

8.1 Licensing of Producers

Biofuels producers, like any other petroleum product producers, need to be licensed by the
Petroleum Products Controller: “A person may not- (a) manufacture petroleum products
without a manufacturing licence… issued by the Controller of Petroleum Products”. Thus under
the act all petroleum producers small and large will have to apply for a manufacturing licence.
Biodiesel producers are already registered with SARS for the fuel levy exemption. This
registration needs to be extended to bio-ethanol producers.

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The licence will apply only to qualifying producers up to a 2% penetration level of locally
produced biofuels, for qualifying litres. Once the required level of production and biofuels
penetration level has been reached, the licensing will be reviewed and adjusted accordingly.
Biofuels producers will have to meet the licensing condition which will include amongst others,
crop selection, feedstock availability, quality requirements, environmental standards
(Environmental Impact Assessment) and water restrictions.

8.2 Off-take by Petroleum Wholesalers Based on Discounting

Biofuels economics are optimised when logistics and costs are minimised. Hence the preferred
off-takers, excluding own use by producers and directly by consumers close to biofuels plants,
will be via the existing oil industry at the depots, or refineries closest to the biofuels plants. This
would involve blending biofuels components in accordance with SANS standards. Currently
this amounts to 5% for biodiesel and up to about 10% for fuel ethanol. Higher levels,
particularly of biodiesel, could be used in dedicated fleets. Using the existing oil industry helps
ensure quality control. With some level of discounting to the Basic Fuel Price (BFP) of the
competing mineral petroleum product, oil wholesalers should take biofuels.

Mandatory blending is not recommended for the 2% incubation phase. Over time, as the
biofuels industry matures, the existing wholesale licences can be amended to mandate the
uptake of biofuels. However, the mandating of biofuels could be done under the section 9(g) of
the Petroleum Products Wholesale Licence regulations (R287, 27 March 2006) or via an
instruction from the Controller of Petroleum Products in terms of section 12(3)(h)(ii) of the
regulations. The price for such licensed volumes could be based on BFP. A discount can be
included to account for the actual relative value and to cater for additional depot and market
handling costs. Section 2(1) (c) of the Petroleum Products Amendment Act provides for the
regulation of petroleum products prices, should this be required.

8.3 Fuel Levy Exemption

The existing Fuel Levy exemption should continue. Based on job creation benefits, an increase
in the exemption to 100% is justified. It is proposed that the biodiesel exemption be fixed at
50% from the 2008 financial year, taking into account the limitations imposed by the diesel tax
refund. Bioethanol producers, on the other hand, should receive a 100% fuel levy exemption
from 2008. The increased support for bioethanol producers will be balanced by the higher oil

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price floor for biodiesel producers. This will ensure that both sets of biofuels producers receive
equal support per litre of qualifying production.

Biofuels production should also include participation by small investors and producers.
Currently biodiesel plants producing under 300 000 litres/annum are fuel tax exempt, and it is
recommended that this fuel tax exemption continue. This level was motivated by the need to
simplify administrative procedures and is very low when seen against the oil industry, where a
typical refinery produces 20 000 times this volume (exempted biodiesel volumes would
constitute 0.005 % of oil refinery volumes) and there is an allowance for product losses of
about 0.05 %. Accordingly it is recommended that the small producers’ threshold be raised to
1.2 million litres per annum for administrative fairness.

8.4 Agricultural Support

The Department of Agriculture has a number of programmes to support development of local

agricultural production and value addition. These include programmes for small-scale and
emerging farmers. Such programmes can be targeted to support farmers in crop selection,
hedging, agricultural methods, logistics, infrastructure, research and development, and in
negotiating contracts with biofuels manufacturers.

8.5 Capacity Building and Development

Government should ensure the training and capacity building of previously disadvantaged
communities and emerging entrepreneurs to maximise transformation and the benefits
inherent in this industry. These activities should be performed in conjunction with the Sector
Education and Training Authorities (SETAs), particularly in the agricultural and energy sectors.
It is envisaged that the new biofuels industry be a driver of transformation and skills
development, coupled with sustainable job creation.

8.6 Government Agencies

Bringing under utilised agricultural land into production not only creates greater macro-
economic benefits but also entails higher investment risk. To ensure such development takes
place, which may correspond with poverty nodes, government agencies, such as the Central
Energy Fund (CEF) and the Industrial Development Corporation (IDC) should become
involved, with support from the provincial agricultural departments. The CEF and IDC should

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maximise Black Economic Empowerment (BEE) in such developments, particularly by
including exit strategies allowing them to sell their investments to BEE players. These BEE
investors could be assisted by the National Empowerment Fund and any other programmes
that may be introduced.

State Owned Entities (SOEs) can play an important if not a leading role in getting the infant
biofuels industry off the ground. Their roles will be different according to their various functions.
On the supply side, Central Energy Fund (CEF) and the Industrial Development Corporation
(IDC) will play a role as investors in public private partnerships or even as investment
consortium leaders or indeed even as individual investors. They might even consider playing a
role as lenders to biofuels projects. The strengths they bring to bear are a commercial
approach and project evaluation which could be useful to small and medium enterprises. The
Land Bank can play a crucial role in financing small farmers or small farmer cooperatives.

On the demand side some SOEs and Government Departments and agencies are large
consumers of fuels. Examples are Transnet, Eskom and the Department of Defence. Again,
Government wishes to play a role on the demand side by, for example, specifying in tender
requirements that biofuels constitute a part of the fuel supply contract. A key requirement for all
such SOEs or Departments is that their shareholder compacts or Departmental strategic plans
reflect their roles in carrying forward the implementation of the Biofuels Strategy. This
requirement places the onus on the “shareholder departments” to ensure that the shareholder
compacts contain such provisions.

9 Other
9.1 SADC Integration

The agricultural production potential is greater in many of our SADC neighbours. Accordingly
any biofuels developments in these countries should be encouraged in as far as they benefit
the region, specifically regarding job creation and economic growth. However, given the early
stages of the South Africa biofuels industry it would be prudent to focus on local development
first. The SADC Energy Protocol, which includes fuel specification rationalisation, should be
used to encourage inclusion of biofuels in the regional fuel pool and develop regional biofuels
specifications. South Africa, by embarking on a biofuels development programme, will facilitate

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our involvement and leadership in the regional biofuels industry. There is scope for future co-
operation in biofuels projects throughout Sub-Saharan Africa within existing NEPAD energy
projects.

9.2 Future Research and Development

It is expected that the demand for biofuels will increase gradually overtime and necessitate the
innovative solutions to the current limitations (feedstock and technology) to be sought through
research and development (R&D). In this regard South Africa will create an R&D platform that
will allow for the strengthening of local capacity and also leverage on international R&D work.
The DST together with relevant stakeholders within the National Systems of Innovation (NSI)
will facilitate the development and coordination of this work through a biofuels R&D plan that
will focus on the total value chain. The research focus areas will include the investigation of
alternative feedstock, development of energy crops (i.e. drought tolerance, high yield per ha,
energy efficiency etc.) and improvement of known technologies whilst further developing,
supporting and piloting the second generation technologies.

10 Implementation Plans

The Biofuels Task Team focused on determining an achievable level and type of national
biofuels industry, and the policy measures needed to ensure this. Until the Strategy is
approved it did not make sense to develop a comprehensive implementation plan and hence
there was only a limited examination of implementation details. The proposed policy requires
partnerships and support from a number of stakeholders, many of them in the private sector,
for its success.

Implementation aspects were, however, covered briefly to give stakeholders an idea of what is
being considered, but details will be developed when the Strategy is approved. It is
recommended that the BTT continues but that it shifts its focus to implementation, monitoring
and strategy refinement.

Given the availability of existing mechanisms and funds, the infancy of the biofuels industry
and the desired phasing-in thereof, it is prudent to start with existing funds and resources.

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10.1 Communication and Education

Public education will constitute an important element of Strategy implementation. The BTT in
collaboration with Government Communication and Information System (GCIS), should lead
the biofuels communication drive, emphasising the incentives and requirements to comply.

10.2 Monitoring and Evaluation

Monitoring and evaluation will primarily be enabled by the licensing system for biofuels
producers and petroleum wholesalers. In addition, the reasonable return on assets scheme will
provide ongoing liaison with producers and developments. This will be done by the DME with
assistance from the BTT. The DME approach will be to refine the strategy as the industry
develops – this is common practice in most countries even with longstanding biofuels
programmes, typically having major review every five years. Once the initial 2% penetration
level has been achieved, a formal review of the Strategy will be held. It is expected that this
should occur at least before 2013.

10.3 The Way Forward

The immediate focus is on incubating the industry to a 2% biofuels penetration level and
encouraging the use of agricultural feedstocks from currently under utilised lands. For this
goal to be realised, the support mechanism needs to be finalised and announced. Initially the
ambit of the fixed margin support mechanism should be communicated, and submissions as to
the levels (SA cpl) required for this be obtained. This would enable the approved support
mechanism to be introduced as part of the 2008 budget.

The support level should be fixed for the first 2% biofuels investment through to 2020 to give
investors some certainty and a decent rate of return on their assets. The fixed support in SA
cents per litre would, due to inflation, translate into a reduced level of real support over time.
In addition, the criteria for approving the 2% investment will need to be finalised. Specifically,
only litres produced from agricultural feedstock grown on under utilised land in the former
homelands will qualify. Care should be taken to ensure investment incentives are only
approved for the 2% penetration level, irrespective of the number of applicants. This is to avoid
over exposure of the fiscus and/or consumers.

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