Required Report - public distribution

**Date:** 5/26/2006

**GAIN Report Number:** JA6024

JA6024

**Japan**

**Bio-Fuels**

**Bio-Fuels Production Report**

**2006**

**Approved by:**

![](media/image1.wmf)Deanna M.J. Ayala

U.S. Embassy Tokyo

**Prepared by:**

Hisao Fukuda/Aaron Kingsbury/Kakayu Obara

**Report Highlights:**

Unlike the United States, Japan has few prospects for production of
biofuels. In the interest of meeting its Kyoto Protocol commitment to
reduce CO2 emissions by 6% from the 1990 level by 2010, the Government
of Japan (GOJ) is committed to importing ethanol for use in ETBEs. The
GOJ also supports an ethanol blend of up to 3% and is engaged in a
number of feasibility studies for the production and distribution of
ethanol. Preliminary indications are that production is severely limited
by Japan\'s shrinking agricultural production.

Includes PSD Changes: No

Includes Trade Matrix: No

Trade Report

Tokyo \[JA1\]

\[JA\]

**SUMMARY/OVERVIEW**

The biofuels situation in Japan is in its nascent stage. There are at
least six feasibility studies under way that are analyzing the prospects
for biofuel production. However, the prospects for production and
distribution of biofuels are severely limited by Japan's shrinking
agricultural production. In order for biofuels to be adopted nationwide,
Japan would need to import either the raw commodities or the biofuels.
Indeed, Japan has begun imports of ethanol from Brazil and is
incorporating them into ETBE production. The primary force driving the
Government of Japan's move toward biofuel study and use is its
commitment under the Kyoto Protocol to reduce emissions. If Japan were
to expand its biofuels use it would essentially be substituting
petroleum imports for biofuel imports.

# BIO-FUELS POLICY

Domestic Policy Environment

Japan's domestic environment is fundamentally distinct from that of the
United States because of Japan's position as an importer of 60% of its
food. For Japan, the prospect of moving toward renewable fuels simply
substitutes dependence on oil producers with dependence on grain
producers. The main impetus for establishing a biomass policy is the
commitment made by Japan under the Kyoto Protocol to reduce CO2
emissions by 6% from the 1990 level by 2010. To reach that goal, the
Government of Japan's (GOJ's) plan is to replace fossil fuels with
500,000 kl (oil basis) ethanol for the transportation sector by 2010.
Most of that fuel will come from imports. They are also looking at ways
to increase fuel efficiency to reduce emissions. On May 18, 2006 the
Ministry of Economy, Trade and Industry (METI) introduced a new strategy
to decrease fossil fuel dependency by 20% by 2030. The final report is
due by May 26, but information so far indicates that the focus is on
raising oil reserves, increasing exploration, and raising the maximum
percentage of ethanol mix from 3% to 10% by 2020.

Several ministries collaborate on Japan's renewable fuels policy:
Ministry of Environment (MOE), Ministry of Economy, Trade and Industry
(METI), and Ministry of Agriculture Forestry and Fisheries (MAFF). MOE's
main concern is meeting Kyoto Protocol commitments; MOE would also be
interested in expanding ethanol use. METI collaborates with industry and
is interested in analyzing the cost-benefit of shifting to renewable
fuels and is thus involved heavily in feasibility studies. MAFF is
interested in utilizing existing biomass (monster cane, woody material,
etc.) in the production of energy and also promoting sustainable rural
economies; indeed there is hope that these programs will help to
revitalize rural areas and reinforce the "multifunctionality" of
agriculture. Also involved is the GOJ's New Energy and Industrial
Technology Development Organization (NEDO), which manages R&D project
planning and development and post-project technology evaluation
functions on a wide range of topics. NEDO is managing several of the
biomass studies ongoing in Japan.

Japan's first biomass plan, Biomass Nippon Strategy, was unveiled in
2002. The Strategy analyzed biomass resources and set targets for the
future introduction of biomass with the goal of increasing utilization
of domestic food waste, wood and other materials. A 2005 review
indicated that while Japan was on track to meet its 2010 goals for food
waste it was not for wood. In addition, the Kyoto Protocol ratification
in February sent Japan into high gear to meet its commitment to reduce
CO2 emissions by 6% by 2010. To do so, Japan's Biomass Strategy sets out
to use 500,000 kl (oil basis) of biofuels for transportation
(contributing to a .6% reduction in CO2). The plan incorporated a 2003
decision to allow up to 3% blending of ethanol (E3) and for ETBE
blending up to 8% (please see Japan's Law for Securing Quality of
Volatile Oil for details). In practice, since January 2005 six gasoline
stations have offered E3 blended gasoline.

Japan's ethanol blend limit is low by U.S. standards and that is because
Japan is taking its usual cautious approach to introducing a new
technology with potential safety implications. A number of potential
hazards have been raised. First, according to the Japan Automobile
Manufactures Association (JAMA), METI tests showed some corrosive impact
to aluminum and rubber car parts in vehicles using E5 ethanol.
Relatedly, there is concern that above the E3 level ethanol could harm
the petrol delivery infrastructure. Third, the industry raised a red
flag about the potential costs of ethanol blending since the
distribution system would, in their view, have to be altered. Currently
there is no consensus on where ethanol blending would occur (possibly at
terminals or refineries rather than gas stations). Fourth, according to
industry sources, the high humidity in Japan can cause moisture to reach
the ethanol thereby causing "phase separation" (if the moisture exceeds
1,000 ppm in E3 the ethanol will shift into water and the water layer
containing ethanol will separate from the gasoline). Thus, Japan
believes the quality guarantee for fuel would have to be addressed.
Fifth, there is concern that consumers would have to bear additional
costs in order to pass Japan's strict emissions tests. Finally, Post was
told that a number of years ago an ethanol-related explosion made
headline and the GOJ and industry believe that this incident is still
fresh in the minds of the Japanese people making it vital to assure
complete safety of biofuels.

All these factors have led the GOJ to develop a rigorous testing and
monitoring scheme to measure the effects of E3 on vehicles and the
environment and how best to introduce ethanol to the market. In 2004 and
2005, METI commissioned the Japan Petroleum Energy Center to conduct
experimental studies on the prospects for buying or producing,
distributing and using ethanol-blended fuel. The study also addresses
concerns related to fuel quality. The ethanol is refined in Yokohama and
distributed to service stations in: Akita, Chiba, Toyama, Mie, Osaka and
Fukuoka Prefectures. Japan will only begin to consider moving to a
nationwide scheme or to a higher percentage blend when studies such as
this on production and distribution, the production feasibility studies
mentioned above and other ethanol-related R&D not listed herein are
complete. Ironically, at the E3 level it is widely accepted
internationally that CO2 emissions are not reduced and in fact the
environment may be harmed. So, the prospects for moving to a higher
blend based on a success with E3 could be hampered. Certainly it will be
ten years or more before something like E10 would become a possibility.

Additional Costs to Petroleum Industry of Adopting Ethanol

1\. Revamp transport/delivery network (50,000 SS, 230 terminals, 30
refineries, 9 brands)

2\. Construction cost for ethanol mixing equipment

3\. New transportation requirements (ship/train/lorry/tanker)

4\. Construction of equipment at SS (fueling pumps, underground tanks,
etc.)

TOTAL COST ESTIMATE = Y300-500 billion (US\$2.58-4.31 billion)

Estimate provided by NEDO, January 2005

Nevertheless, in Japan's FY07 (April 07-March 08) the GOJ will introduce
a new tax incentive for blending ethanol whereby the Y53.8/liter
distribution tax will be removed. Beginning in FY05 tax incentives of
various degrees were established for consumers purchasing special fuel
efficient or clean-energy vehicles.

With respect to biodiesel, there are no standards but the GOJ is
considering establishing standards. No time frame has been given. There
is some passing interest in processing used vegetable oil domestically
into bio diesel but there is no concerted effort to produce or import
soybeans or other inputs for this purpose. On May 12, 2006, Nippon Oil
Corporation and Toyota Motor Corporation announced they have jointly
developed a palm oil-based biodiesel that performs comparably to
gasoline. They claim to have removed the oxygen from the palm oil, which
would normally cause the fuel to degrade. Nippon Oil aims to develop a
commercially viable biodiesel by 2010. Current annual production of
biodiesel from used vegetable oil is estimated at 2 to 3,000 kl.

On the other hand, the introduction of ETBEs has become generally
supported by the industry. There are currently four MTBE facilities
sitting dormant in Japan that would be able to get back into production
making ETBEs. In addition, ETBEs could relatively easily be used on a
national scale while ethanol blends would only be feasible locally or
regionally. METI organized a working group in April 2005 to study the
feasibility of ETBE usage: ease of introduction, supply stability and
economic efficiency, CO2 emissions reduction in ETBE-blended gasoline,
safety assessment as a new chemical substance and the status of Europe's
introduction of ETBEs. The report is due at the end of this fiscal year
(roughly March 2007). At this point, the GOJ supports the switch from
MTBEs to ETBEs over widespread ethanol use mainly due to the cost and
logistical implications noted above. In January 2006, the Petroleum
Association announced it would aim to use 360,000 kl of ethanol by 2010
(equivalent to 210,000 kl of oil) to make an 8% ETBE blend. On the
downside, ETBEs still present possible environmental hazards and the oil
industry must show they are taking countermeasures to reduce those
potential impacts within about two years' time. The cost of such
countermeasures was not disclosed.

According to JAMA, there are 70 million automobiles in Japan (gas and
diesel) and domestic fuel consumption is around 60 million kl. If E3
were nationalized it is estimated that demand for ethanol would be
around 1.8 million kl. In the case of E10, demand would be 6 million kl.
The Japanese gasoline market is made up of large companies and no
independent dealers. Only a handful of companies import oil and/or
gasoline. These roughly ten companies are organized into four groups.
They sell to their own contacts in a very formalized distribution
system.

Despite somewhat lackluster sales in the past ten years, the automobile
industry remains a critical part of the Japanese economy -- and a symbol
of national pride. The Japanese automakers have a cautious approach to
integrating biofuels into the Japanese market. The automakers see ETBEs
as a relatively painless change in that at the percentage rates ETBEs
are being incorporated (8%, even at 20-25%) they have very little to no
impact on car parts and no changes to the production or distribution
infrastructure are required. JAMA has conveyed concerns to the GOJ that
ethanol blends at E5 or above would harm car parts (e.g. the fuel line
erosion) and possibly pipelines. One report estimates the cost to
replace or upgrade existing infrastructure would be Y300-500 billion
(\$2.58-4.31b, please see table above). Ironically, many of the same
cars that would be subjected to robust testing before ethanol would be
used are already being sold in the United States. Indeed, JAMA
acknowledges this fact and states that if the GOJ adopted an E10 ethanol
policy the automakers would be prepared to support it. The GOJ and the
automakers agree that it is vital to continue to pursue fuel efficiency
as another means of reducing CO2 emissions. So, the bottom line is that
all of the possible positive and negative factors much be weighed and
studied before any change is made and at this point the automakers are
not convinced that the costs would be worth the gains.

Domestic production of renewable fuels is minor. The GOJ has six
"feasibility studies" calculating the potential for production,
distribution and use running in different locations around the country.
For example, in Hokkaido they are investigating the prospects for
converting "non-spec" wheat (not suitable for consumption) and wood
waste. In the Okinawa area they are working on conversion of "monster
cane" to ethanol. Production of ethanol from molasses is also under
study. The sugar subsidy system will be revamped in 2007, abolishing the
minimum price moving sugar cane and sugar beet production into different
support sectors. (In recent years, production of beets has risen while
cane has declined. Cane is used in ethanol production in Japan because
beet is less efficient. For more on Japan's sugar situation please see
GAIN Report #6008: Sugar
Annual<http://www.fas.usda.gov/gainfiles/200602/146176734.pdf>.) Cane
will have a commodity-specific subsidy while beets will fall under the
blanket direct payment. The outlook is for 19 additional facilities to
go on line in 2006 and 25 more in 2007. MAFF estimates that, if
commercialized, Japan could reasonably expect to supply only 360,000 kl
per year. Meanwhile MOE expects Japan could meet only 10% of the 500,000
kl target with domestic ethanol production.

One Japanese company has developed a patented "nanotechnology membrane"
that enables cost reduction during ethanol dehydration. That company
also has invested in Brazil in an effort to improve ethanol production,
supply and supply logistics.

The alcohol industry is not in a position to fill any gaps in the
domestic renewable fuels market. Demand for alcohol is around 540,000
kl/year and has been increasing slightly for the past 10 years. The bulk
of the raw materials must be imported (in the form of crude alcohol)
primarily from China, Brazil and Thailand. A small amount is
occasionally imported from the United States. Until April 2006, the
market was controlled by Japan's government-owned industrial alcohol
"company", at which point it was privatized. Roughly 294,000 kl of
industrial alcohol are produced annually. The main uses of industrial
alcohol are for food (vinegar, soy, etc.) followed by chemical and then
household use. Alcohol for fuel use is limited to the government trials
underway.

In Japan, there is not a noticeable consumer movement toward renewable
fuels. Although hybrid vehicles are frequently seen about the country,
the main factors driving consumer decisions are (a) passing Japan's
strict emissions tests and (b) the price of gasoline. Prior to taxes,
retail gasoline is Y35-45/liter.

Given industry's reluctance and the lack of market potential for
domestic crops, Japan's renewable fuels prospects are largely guided by
government policy rather than market forces.

# Import Regimes for Bio-Fuels

Japan began importing notable amounts of ethanol in 2001, roughly 472
million liters. Since that time the volume has grown to 509 million
liters total from the world, including roughly 359 million liters from
Brazil. In 2005 the Brazilian Agriculture Ministry reported exports of
ethanol to Japan were mainly for use in chemical products and alcoholic
beverages.

The widespread use of ethanol in Japan is somewhat influenced by the
import and domestic tax structures. The import tax on crude oil is
Y0.17/l. The import duty on alcohol (including ethanol) was 27.2% but
starting in FY06 was lowered to 23.8% and will go down each year until
it reaches 10% in 2010. The incremental tax structure for gasoline and
ethanol is below. The GOJ estimates that inclusive of all taxes, the
cost of gasoline is roughly Y123.7/l versus imported ethanol at
Y149.7/l.

COMPARISON OF TAXES APPLIED TO GASOLINE AND ETHANOL

  -------------- ----------------------- ------------- ------------------
  Gasoline                               TOTAL TAX     AVERAGE PRICE
  Taxes:                                               

                 Y 0.17/l Import Duty    Y56.01/l + 5% Y123.7/l
                 for Crude Oil                         

                 Y 2.04/l Petroleum and                
                 Coal Tax (paid by                     
                 refiners)                             

                 Y 53.8/l Consumer                     
                 Tax/Gasoline Tax                      

                 5% Consumer Tax (paid                 
                 at retail)                            

  Ethanol Taxes:                                       

                 27.2% Import Duty for   27.2% +       
                 Ethanol\*               Y53.8 + 5%    

                 Y 53.8/l Gasoline Tax                 Y149.7/l

                 5% Consumer Tax (paid                 
                 at retail)                            
  -------------- ----------------------- ------------- ------------------

\* The import duty for ethanol will be reduced to 10% by FY10.

Up to now, Japan has seen Brazil as the only possible reliable supplier
of ethanol. In 2004, Prime Minister Koizumi visited Brazil, where the
Brazilians created a favorable impression of their sugar cane ethanol
production. In 2005, the Brazil-Japan Working Group on Biomass was
established to share information and examine possible avenues for
bilateral cooperation. Also that year, Brazil's state-owned Petrobras
Internacional Braspetro BV incorporated with Japan's state-owned Nippon
Alcohol Hanbai KK to form Brazil-Japan Ethanol Co., Ltd. The company is
the exclusive franchise for Brazilian ethanol imports in Japan and will
also be involved in R&D related to ethanol use and distribution. In
April 2006, Brazil's Foreign Minister and Minister of Commerce came to
Japan and the two countries agreed that Brazil would supply 210,000 kl
(oil basis) of sugar cane-based ethanol to Japan. This will be used to
make E3 blends of high-octane fuel that account for about 20% of all
gasoline in Japan. Despite this friendly alliance, some in Japan are
skeptical Brazil will be able to keep up with export demand given the
growth of Brazil's domestic demand. In addition, they worry that if the
price of sugar for food use goes up Brazil's ethanol supply will be
diverted. One study by MAFF shows that if Japan were to nationalize E3
the world sugar price would increase 1%. They are also watching what
happens to the EU sugar regime for similar reasons. Japan will also
investigate India as a possible supplier. Japan already imports roughly
60% of its sugar.

Imported ethanol costs roughly Y20 to Y40 more than gasoline in terms of
calories (the calories per liter of gasoline is equivalent to 1.7 liters
of ethanol). Ethanol blends are estimated to cost Y0.6 higher per liter
than regular gasoline.

# BIO-FUELS STATISTICS AND ANALYSIS

**Trade Tables:**

\(a\)

  -------------- ------------------ ------------- ------------- ----------------
  Production and                                                
  Distribution                                                  
  of Biofuels:                                                  
  Ethanol (in                                                   
  1,000 L)                                                      

  Year           Production         Imports       Exports       Total Use

  2001           0                  471637        254           471384

  2002           0                  432616        1176          431440

  2003           0                  403911        132           403779

  2004           0                  494562        207           494355

  2005           0                  509161        22664         486497
  -------------- ------------------ ------------- ------------- ----------------

HS Codes: 220710, 220720

\(b\)

  -------------- ------------- ------------- ------------------ ----------------
  Production and                                                
  Distribution                                                  
  of Biofuels:                                                  
  Residuals of                                                  
  the Chemical                                                  
  Industry                                                      
  (000MT)                                                       

                                             Biodiesel          

                 Imports       Exports       Production         Total Use

  2001           585.4         174.0         0                  411.4

  2002           525.3         208.3         0                  317.0

  2003           482.2         216.6         0                  265.6

  2004           455.8         248.5         0                  207.4

  2005           455.9         256.3         0                  199.6
  -------------- ------------- ------------- ------------------ ----------------

HS code: 382490

Annual production of biodiesel from used vegetable oil is anecdotally
estimated around 2,500 kl. Production of bio-diesel from other inputs is
minimal.

\(c\)

  -------------- ------------------ ------------- ------------- ----------------
  Production and                                                
  Distribution                                                  
  of Corn                                                       
  Sweetener\*                                                   
  (in 1,000 MT)                                                 

  Year           Production         Imports       Exports       Total Use

  2001           731.39             29.61         0.02          761.00

  2002           740.05             27.95         0.02          768.00

  2003           755.44             35.56         0.02          791.00

  2004           764.33             31.67         0.04          796.00

  2005           743.92             38.08         0.12          782.00
  -------------- ------------------ ------------- ------------- ----------------

Table refers only to HFCS solids, HS code 170250

Corn sweetener production is regulated under Japan's starch policy,
which aims to support domestic (potato) starch and sugar producers. Corn
for starch is imported without duty but under a quota system (HS
100590091) whereby cornstarch processors must pay a levy on the starch
produced from imported corn and must also use a certain percentage of
domestic potato starch. Cornstarch demand is about 2.53 million
tons/year and has been strong in recent years, primarily due to a strong
beverage demand for corn sweeteners. 84% of Japan's starch demand is met
by production from imported corn (primarily US origin). With respect to
high fructose corn syrup, demand is roughly 1.2 million tons/year of
which 1.1 million tons is US origin. (For additional information on
grains please see GAIN #JA6012,
<http://www.fas.usda.gov/gainfiles/200603/146176973.pdf>.)

\(d\)

  --------------- ------------ --------- ---------- --------- ------- ------ --------- ------------ ---------
  Production and                                                                                    
  Distribution of                                                                                   
  Feedstock                                                                                         
  Commodity                                                                                         

  Incorporating                                                                                     
  Use for                                                                                           
  Bio-Fuels                                                                                         
  Production:                                                                                       
  Corn Use (in                                                                                      
  1,000 MT)                                                                                         

                                                                                                    

                                                                                       Sweetener    

  Year            Production   Imports   Total      Exports   Feed    Food   Biofuel   Production   Total
                                         Supply\*                                                   Use\*\*

  2001            1            16395     17693      0         12000   2907   0         0            17693

  2002            1            16868     18262      0         12300   3038   0         0            18262

  2003            1            16781     18239      0         12400   3161   0         0            18239

  2004            1            16485     17825      0         12200   3375   0         0            17825

  2005            1            16500     17626      0         12100   3474   0         0            17626

                                                                                                    
  --------------- ------------ --------- ---------- --------- ------- ------ --------- ------------ ---------

\*Total supply includes stocks

\*\*Total use includes end stocks

\*\*\* Imports are for MY Oct-Sep

\(e\) Bio-Fuels' Impact on Traditional Users such as Feed, Food, Trade

The main impact on the feed and food sectors in Japan will be due to any
shortages in supply of commodities like corn and soybeans due to
increased biofuel production in the United States and other countries.

Exchange rate: \$1 = Y 116

1 Liter = 0.26 Gal (1 Gal = 3.79 Liters)