### Required Report

- public distributio n

Date: 2009

- 7

- 1 7



### GAIN Report Number: CH905 9



# China

- Peoples Republic o f

BIOFUELS ANNUA L

China Biofuels Annual

Approved By:

Michael Woolse y

Prepared By:

Chanda Beckman and Jiang Junyan g

Report Highlights:

China’s fuel ethanol production is forecast to rise to 1.70 million metric tons (MMT) in 2009, an increase of eight

percent compared to 2008. The GOC’s policy to restrict grain processing (including fuel ethanol) is forecast to be

unchanged in 2009 and beyond, as food security concerns top the governme nt’s agenda. In the wake of food price

increases in 2007, the government halted approval of any new grain processing projects (including fuel ethanol

plants). The government’s policies have turned to support non

- grain based fuel ethanol production; howev er, the

sector’s growth is constrained by limited feedstock supplies, which compete with land use for grain production.



### Post:

Beijin g Commodities:

select

### Executive Summary:

China’s fuel ethanol production is forecast to rise to 1.70 million metric tons (MMT) in 2009, an

increase of eight percent compared to 2008. The GOC’s policy to restrict grain processing

(including fuel ethanol) is forecast to be unchanged in 2009 and beyond, as food security

concerns top the government’s agenda. In the wake of food price increases in 2007, the

government halted approval of any new grain processing projects (including fuel ethanol

plants). The government’s policies have turned to support non

- grain based fuel ethanol

production; however, the secto r’s growth is constrained by limited feedstock supplies, which

compete with land use for grain production.

The official government guidelines for the biofuel sector are that biofuel development

(including fuel ethanol and bio

- diesel) should not compete with crops intended for human

consumption. According to the new government policy, cassava, sweet potato, and sweet

sorghum are viewed as potential feedstock for new ethanol plants in the coming

years. However, the current domestic production of cassava, sweet potato, and sweet

sorghum is not able to sustain large scale ethanol production, as most of these crops have to

be planted on marginal, less fertile land.

To date, there are five plants licensed for fuel ethanol production. Among them, there are four

plants (located in Jilin, Heilongjiang, Henan, and Anhui Provinces) that use grain

- based

feedstock. Their production totaled 1.46 MMT in 2008. It is estimated that 80 percent of

production is corn based and the remaining 20 percent is wheat or rice based. The fifth plant

(in Guangxi Province), which started trial operations in December 2007, was designed to

produce at an annual capacity of 200,000 tons, using only cassava as its feedstock. Its fuel

ethanol production reached 120,000 tons in 2008, as prescribed in the E10 mandate (10

percent ethanol blended into fuel) the province has already implemented.

Overall annual biodiesel production capacity in 2008 is estimated at three MMT, however

actual biodiesel production in 2008 is estimated at 250 ,000 MT. Feedstock for biodiesel

production is scarce in China, given that China is a net importer of vegetable oils such as soy

and palm oil for food consumption. Currently, the main feedstock is waste cooking oil from

restaurants, which is difficult to collect on a commercial scale for biodiesel production.

Note: During the 11th five

- year plan (2006

- 2010), the Chinese government made clear that it

will not approve any new plants that use corn or other grains as feedstock, which virtually

capped the u sage of grains (corn, wheat, and rice) at the current capacity. For a complete

report on China’s grain situation, please refer to GAIN report CH9013.

The official guidance policy relevant to the biofuel sector has been unchanged since 2007.

Please refe r to CH7039 and CH8052 for complete background information.

### Author Defined:

Biofuel Situation

China views biofuels as essential and strategic components of a secure economy and

diversified energy policy. To ensure the development of biofuels, the ce ntral government has

taken an active role in regulating both the supply and demand side of the biofuel market and

has limited ownership of production facilities to the state industry. The National Development

and Reform Commission (NDRC) has been China’s leader in the development of biofuels

,

guiding future energy production and consumption in China, as well as industry’s participation

in the sector.

There are five fuel ethanol plants (located in Jilin, Heilongjiang, Henan, Anhui and Guangxi

Provinces ) currently licensed for operation. Among them, there are four grain

- based plants

that have reached full capacity. Their total usage of corn (and wheat) for ethanol will remain

at the current level. The fifth plant (in Guangxi Province) began trial oper ations in December

of 2007, with designed annual capacity at 200,000 tons, based entirely on cassava

feedstock. Its fuel ethanol production reached 120,000 tons in 2008, as required by a

provincial E10 mandate.

Food security has been a top issue on th e central government’s agenda. Escalating food prices

since 2007 have triggered a series of policy shifts in the industrial use of grain. To reduce

industrial grain consumption, the government denied approval of any new grain

- based

processing projects (i ncluding fuel ethanol plants) in 2007 and 2008.

State policy prescribed that biofuel development (including fuel ethanol and bio

- diesel) should

not compete for arable land designated for crops for human consumption. The future

development of feedstock f or biofuel will necessarily have to come from marginal, less arable

land; and therefore increase of planting tuber crops and sweet sorghum is a realistic

expectation. Some provincial governments and private companies are already experimenting

with sweet p otato and sweet sorghum as feedstock for biofuel production. However, current

production of such crops is far from sufficient for large

- scale industrial ethanol production, as

supply of these feedstock has been seasonal and low yielding. Given the curren t crop

limitations and transportation logistics, the feasible production capacity of a biofuel plant based

on tuber crops and sweet sorghum will not exceed 100,000 MT annually, according to industry

estimates.

To maintain low energy costs for all sector s, the central government provides subsidies to

state refineries for gasoline and diesel production. More importantly, price control or

stabilization on strategic commodities has been a key function for the relevant government

agencies; as a result, domes tic gasoline and diesel prices sometimes do not follow the

international market price. The domestic fuel price swing is less volatile than internationalprices. The government evaluates international oil prices periodically to determine a

benchmark price for gasoline and diesel for domestic distribution.

The latest oil pricing mechanism announced by NDRC took effect earlier this May, and states

that domestic fuel prices should be adjusted when global crude prices fluctuate by more than

four percent for 22 working days in a row.

The fuel ethanol price is linked to set government fuel prices and then marketed by state

designated retailers. Due to relative high prices on feedstock including corn, wheat, and rice,

the five fuel ethanol producers still r eceive government subsidies to cover losses under the

current pricing regime. This pricing regime also functions to discourage the private sector’s

investment in fuel ethanol production.

Government Subsidy for Fuel Ethanol Production

(in U.S. $/Metric Ton)

2005 2006 2007 2008*

270 239 202 258

* Post estimate on the average amount for the five

plants in 2008 (U.S.$ 1 = RMB 6.8)

In 2008, the average subsidy for fuel ethanol production set by the central government

reached $258/ton, while it was approximately $202/ton in 2007 and $239/ton in 2006. The

rise in the subsidy amount is primarily due to high grain prices in 2008. Since 20 08, the

government started to implement a flexible subsidy program for all five fuel ethanol

producers. According to the program, the final subsidy level is based on the actual evaluation

of each individual plant’s performance. The evaluation is schedule d in November of each

year. The program is designed to make more efficient use of government funding to the

sector.

Currently, ten provinces participate in the fuel ethanol program. These ten provinces will

remain the priority for use of an E10 gasoli ne (with a fuel/ethanol mix rate of 10 percent). Six

of these provinces use E10 within their entire provinces, while four provinces have only partly

adopted the product. Close to full adoption by these four provinces remains a priority for the

government 's fuel ethanol program.

Fuel Ethanol Production

Table 1 shows the expansion in China’s fuel ethanol production during the eight year period

2002

- 2009. The fuel ethanol production in 2009 is forecast to grow eight percent from the

previous year, in tandem with fuel market expansion in these ten provinces.

Table 2 (unchanged from the previous report) provides a geographic breakdown of the

production facilities within China in terms of production capacity. It also gives estimatedproduction data for 2009. The Jilin Province ethanol plant has the largest processing capacity

in China with an output of 500,000 MT/year. In 2007, a new plant opened in Guangxi Province

using cassava as a primary feedstock. The province plans to increa se ethanol production

(based on cassava) with the goal of reaching 1 MMT by 2010. Industry sources report that

other plants using sweet potato as feedstock will be submitted for approval to the NDRC and if

approved these plants located in Hebei or Sichuan

, might begin construction in 2009. These

plants’ individual annual capacity will have to be below 100,000 tons, given the limited

feedstock supplies.

Table 1. A Historical Look at China’s Fuel Ethanol Production

Year Production Quantity % Inc rease from Previous

Year

2002 and before Official fuel ethanol production

began in 2004. There is little

recorded fuel ethanol production

before 2002. NA

2003 <20,000 MT/year

2004 300,000 MT/year 1,400%

2005 920,000 MT/year 206%

2006 1,300,000 MT/year 41%

2007 1,370,000 MT/year 5%

2008 1,580,000 MT/year 13%

2009 1,700,000 MT/year 8%

Sources: Industry Sources

Table 2. Current Fuel Ethanol Production

Location

(Province,

City) Company Name Principal

Feedstock Estimated 2008

Production

(MT/year) 2009

Production

Capacity Supply Location

Heilongjiang,

Zhaodong China Resources

Alcohol Co. Corn/Rice 180,000 180,000 Heilongjiang

Jilin, Jilin Jilin Fuel Ethanol Co. Corn 470,000 500,000 Jilin

Liaoning

Henan,

Nanyang Henan Tian Guan

Fuel

- Ethanol Co. Wheat 410,000 450,000 Henan

Hubei (9 cities)

Hebei (4 cities)

Anhui,

Bengbu Anhui BBCA

Biochemical Co. Corn 400,000 440,000 Anhui

Shandong (7 cities)

Jiangsu (5 cities)

Hebei (2 cities)

Guangxi Guangxi COFCO Bio

Energy Co. Cassava 120,000 200,000 Guangxi

Total: 1,580,000 1,770,000

Sources: Industry Sources

*Note 1: The list of cities with an E10 mandate for each province is as follows:Hubei : Xiangfan, Jingmen, Suizhou, Xiaogan, Shiyan, Wuhan, Wichang, Huangshi, and

Ezhou

Hebei : Shijiazhuang, Baoding, Xingtai, and Handan (locations supplied by Henan)

Shando ng : Jinan, Heze, Zaozhuang, Linyi, Lioacheng, Jining, and Tai’an

Jiangsu : Xuzhou, Lianyugang, Huai’an, Yancheng, and Suqian

Hebei : Canzhou and Hengshui (locations supplied by Anhui)

*Source: Law Concerning Testing for the Extensive Use of Ethanol Blende d Gasoline for

Automobiles and the Regulations Concerning the Conduct of Testing for the Extensive Use of

Ethanol Blended Gasoline for Automobiles.

Trade in Ethanol

Both ethanol imports and exports have been minimal in 2008 and 2007. China’s ethanol

exports have dropped substantially since the government removed ethanol export rebate in

2007. In 2007, to discourage the expansion of China’s grain

- processing s ector, the

government removed a 13 percent Value Added Tax (VAT) rebate on ethanol exports. This

rebate removal substantially cut profits for ethanol exporters.

In June 2009, as part of the central government’s stimulus policy package, the governmenta nnounced a five percent VAT rebate for ethanol export, however due to sluggish external

demand, China’s ethanol exports are not expected to increase significantly in 2009. Partially

due to freight advantages, the neighboring markets Japan, Korea, and othe r Asian countries

are predominant export destinations for Chinese ethanol (mainly food grade).

Ethanol imports to China have been relatively minor in recent years. Due to the relative

cheaper priced feedstock for ethanol production in China

, imported ethanol is not price

competitive.

China Ethanol Exports in 2004

- 2008 in 1,000 LTR

HTS# Description 2004 2005 2006 2007 2008

Total Ethanol 96,912 162,204 1,017,779 129,973 108,110

220710 Undenatured 91,596 158,654 970,721 110,718 100,064

220720 Denatured 5,316 3,550 47,058 19,256 8,047

China Ethanol Imports 2004

- 2008 in 1,000 LTR

HTS# Description 2004 2005 2006 2007 2008

Total Ethanol 4,253 19,590 7,972 678 402

220710 Undenatured 2,021 15,936 5,930 154 293

220720 Denatured 2,232 3,654 2,042 524 109

Source: World Trade Atlas

China Ethanol Exports by Destination in 2004

- 2008 in 1,000 LTR

Country 2004 2005 2006 2007 2008

World 96,912 162,204 1,017,779 129,973 108,110

Korea, South 16,881 39,144 191,642 50,304 34,933

Australia 0 0 0 0 17,685

Taiwan 21,909 22,655 41,811 15,592 14,556

Singapore 46 5,063 59,923 21,659 14,532

Japan 49,975 79,375 113,665 35,420 12,560

Korea, North 6,844 14,648 9,433 5,588 8,467

Others 1,257 1,319 601,304 1,411 5,377

Source: World Trade Atlas

China Ethanol Imports by Destination in 2004

- 2008 in 1,000 LTR

Country 2004 2005 2006 2007 2008

World 4,253 19,590 7,972 678 402

Pakistan 0 0 0 0 194

Japan 1,900 1,807 1,802 179 131

Philippines 0 0 0 0 19

Germany 32 31 91 68 19

United

States 25 35 149 119 13

Malaysia 0 7 3 16 10

Korea, South 40 992 29 12 8

Netherlands 15 7 10 15 7

United 9 31 15 4 1Kingdom

Singapore 35 16 10 5 1

Others 2,196 16,662 5,865 261 1

Source: World Trade Atlas

Overall Ethanol Production

Total ethanol production in 2008 is estimated at 6.5 MMT. Of this total, 1.6 MMT is intended

for fuel ethanol use, and about 2.8 MMT for food use. The reminder is used for industrial and

surgical purpose. About 50 percent of total ethanol production is based on grains (mostly

corn, but also including sorghum, wheat, and rice) with the r emainder based on tubers,

including cassava and sweet potatoes. Overall, total ethanol production in 2008 accounted for

less than 60 percent of total capacity, estimated at more than 11 MMT.

The top five ethanol producing provinces are Jilin, Henan, Gu angxi, Heilongjiang and Anhui,

which are also major grain (or tuber) production regions. These five provinces also host the

current five licensed fuel ethanol plants. (For grain and cassava production data, refer GAIN

CH9013, CH8052)

Imported cassava is also used for ethanol production in coastal regions. Due to a zero tariff on

cassava from southeastern Asian (ASEAN) Countries, imported cassava sometimes is more

price competitive over domestically produced grains or tubers. As shown by the following

table, China’s cassava imports volume fluctuates with price movement. In 2009, being price

competitive, cassava imports from Vietnam and Thailand rebounded subs tantially as Chinese

grains price were artificially boosted by the government purchase program.Source: World Trade Atlas

The imported cassava price averaged about $120/ton in the first quarter of 2009, while it was

$190/ton in the first quarter in 2008. As a result, China’s cassava imports from January

- May

2009 rose 160 percent from the previous year, reaching 2.5 MMT.

China 's Cassava (071410) Imports from the World by Metric Ton 2003

- 2009

2003 2004 2005 2006 2007 2008 2009

Total

Imports 2,368,260 3,442,412 3,335,415 4,950,435 4,625,427 1,976,418 2,495,359

Thailand 1,874,362 2,734,389 2,695,576 3,864,203 3,202,647 1,247,513 1,462,211

Vietnam 453,132 522,296 411,573 941,274 1,279,470 610,679 995,880

Indonesia 40,766 185,728 228,265 144,784 139,124 110,820 34,189

*Note: 2009 data is for January

- May only

Biodiesel

Overall biodiesel production capacity in 2008 is estimated at three MMT. Actual biodiesel

production in 2008 is estimated at 250,000 MT, due to lack of feedstock availability.

Feedstock for biodiese l production is scarce in China, given that China is a net importer of

vegetable oil such as soy and palm oil for food consumption. The most common feedstock for

biodiesel production in China is used cooking oil. However, there is no standard or scale

co llection of used cooking oil. The spotted supply of domestic used cooking oil cannot meet

plants’ desired capacity. Currently, biodiesel plants are small

- scale, ranging from 100 to

20,000 MT of production. These plants usually operate for only a few mon ths out of the year

due to lack of a sufficient supply of feedstock. The lack of feedstock is the result of the short

supply of edible vegetable oils. China is the world’s largest importer of soybeans and importssignificant quantities of other oil based products.

In addition, the biodiesel sector competes with other sector when purchasing feedstock

because used cooking oil can also be used as animal feed ingredient or other chemical

material.

Industry sources report that when fuel prices are high, there is potential for expanded use of

biofuels. However, as fuel prices fall, all profit margins are narrowed; producers can barely

turn a profit without government subsidies or tax incentives. If market conditions become

unfavorable, most biodiesel plan ts will suspend operation to avoid negative cash flow.

Biodiesel prices are primarily influenced by benchmark prices set by NDRC as well as the

supply and demand for petroleum

- based diesel fuel. NDRC sets this benchmark price in

accordance with interna tional fuel prices swings. However, as fuel prices constitute a large

proportion of production costs for all sectors, for the purpose of controlling or stabilizing the

overall domestic prices, this benchmark price sometimes does not follow closely with th e

international market. In a time of high international fuel prices, domestic fuel prices might be

much lower than the international prices. If this pricing regime creates losses for gasoline or

diesel producers (which are state owned), the government wi ll offer subsidy to partially

compensate their losses.

Supportive Government Policy, a Must for the Biodiesel Sector

For private biodiesel producers to be competitive, biodiesel prices have to be lower than the

NDRC benchmark price on diesel. However, t he price for feedstock is market driven. There are

no national or provincial programs to promote the use of biodiesel as transportation fuel and

no government subsidy is provided to biodiesel producers. Due to government control on fuel

prices (which vir tually functions as price ceiling for bio

- diesels), profit margins for private

biodiesel producers are not guaranteed.

Given the current production scale, Post forecasts that the Chinese government will not

promote large

- scale fuel biodiesel use in the near future.

On December 9, 2008, the State Administration of Taxation and Ministry of Finance jointly

issued Policies for Products Generated from Comprehensive Utilization of Resources (Cai Shui

[2008] No. 156), a circular on Value

- added Tax (“VAT”), which stipulated that a VAT refund

would be applicable to enterprises that produce biodiesel by making use of wasted animal oil

or plant oil as at least 70 percent of their raw materials. This VAT incentive policy is e ffective

July 1, 2008. To obtain the VAT refund, an enterprise must first apply for and obtain the

relevant “Comprehensive Utilization of Resources Verification Certificate” and then apply for

the refund. Industry sources report that this policy is not v ery well implemented at the

provincial level due to different interpretation by local taxation authorities. Even for somequalified products, the local authorities did not hand out the refund in a timely manner.

A new revised consumption tax effective January, 2009 stipulated that diesel (biodiesel

included) is subject to a five percent (or 12 cents/LTR) consumption tax, this adversely

impacted the profitability for biodiesel producers. The biodiesel industries (mostly private

ownership) are currently lobbying the government for an exemption to this consumption tax,

however, compared with the state owned fuel ethanol producers, this sector’s lobbying power

is less effective.

Comparison of Tax Incentives for Fuel Ethanol and Biodiesel Product ion

Consumption Tax Value Added Tax (VAT)

Fuel Ethanol 0 0

Biodiesel 5% (or 12 cents /LTR since

January 2009.) *17%

*Interpretation by local taxation authority varies

Major Biodiesel Plants Production Capacity

Company Name Location Annual Production

Capacity

China Biodiesel International Holding Co., LTD Fujian Province 100,000 MT

Wuxi Huahong Biofuel Company Jiangsu Province 100, 000 MT

Hainan Zhenghe Biofuel Energy Company Hebei Province 300,000 MT

Gushan Environmental Energy Limited Sichuan, HeBei, Fuzhou, Beijing 340,000 MT

Source: China New Energy and Renewable Energy Industry Report 2008 and

Post's Estimate

Non

- Grain Feedstock for Biofuel Production

As the government has announced a total ban on grains for use in new fuel ethanol plants,

industry and researchers are working on the feasibility of substitute crops or tree nuts for

future fuel ethanol or biodiesel production. The potential substitution and production regions

are listed below, according to industry sources.

Potential Feedstock and Production Region for Ethanol or Biodiesel Production

Crops Province

Oil Bearing Tree Seeds

(Or Energy Trees) Yunnan, Sichuan, Hunan, Anhui, Hebei, Inner Mongolia and Shaanxi

Tuber (Sweet Potato) Hubei, Hebei, Jiangsu, Jiangxi and Chongqing

Sweet Sorghum Heilongjiang, Inner Mongolia, Xinjiang, Liaoning and Shandong

A recent NDRC evaluation shows that in these provinces, the development of such feed stocks

will not compete with the land use for

- grain production. However, most of the available land

for these crops will have to be marginal, less fertile land.

A separate report by State Forestry Administration (SFA) in 2008 outlined the following three

steps prior the commercialization of biodiesel production:Variety breeding demonstration on energy trees: the government needs to work with

industry to develop variety breeding de monstration, by 2010, SFA plans to complete 14

demonstration projects nationwide for variety breeding.

Cultivation demonstration on energy trees: by 2010, SFA plans to complete 22

demonstration projects nationwide on the cultivation and harvesting of energ y forestry.

Demonstration projects on biodiesel production: In 2008 NDRC approved three

demonstration projects on bio

- diesel.

Three Biodiesel Demonstration Projects approved by NDRC in 2008

Participants Production Capacity (MT) Location Feedstock

Petro China 60,000 Sichuan Province Jatropha

SinoPec 50,000 Guizhou Province Jatropha

CNOOC 60,000 Hainan Province Jatropha

According to a notice by NDRC in 2008, “ the construction of the three demonstration

biodiesel projects will help support and regulate the biodiesel sector’s development and avoid

duplicated construction and investment. Three state

- own petroleum companies were selected

for the construction of t hese three projects.”

(Source: NDRC website)

So far, there is no timetable on when the projects will be completed. However, jatropha has

been designated as the feedstock and it normally takes up to five years before the trees to

reach prime harvest stage. State media reports that some trial planting for jatropha started in

2007, but Post estimates jatropha production will not be able to sustain any scale industrial

production in 2009 and 2010. In the long term, through these demonstration projects

, NDRC

plans to accumulate more management experience and form methodologies for biodiesel

production, storage, marketing and usage, and thus lay a sound foundation for the future trial

use of fuel biodiesel in the country.

MOU on Biofuel Cooperation Ac tivities between the United States and China

In December 2007, the United States Department of Agriculture (USDA), Department of

Energy (DOE) and NDRC signed a Memorandum of Understanding (MOU) on cooperation in

biofuel development. Based on this MOU, the two countries have proposed to cooperate

closely in the scientific, technical, and policy aspects of biofuel development.

Both sides agree that agriculture will play a more important role in low

- carbon economy in the

future. Biofuel and energy agricu lture are of vital importance to the development of a low

carbon economy and rank as one of the major agricultural measures to cope with climate

change.

Currently, USDA, DOE, and NDRC are working on cooperation proposals, which cover thefollowing areas : cellulose ethanol, algae biodiesel, non

- grain based ethanol production (using

sweet potato and sweet sorghum as feedstock), and thermo chemical conversion of

biomass. With more industry participation expected in the future, this cooperation might bring

more concrete progress in technical breakthroughs.

Fuel Use in China

Auto sales in China in 2009 are estimated to grow six percent. Post estimates that transport

fuel (diesel and gasoline) demand will grow five percent in 2009. Diesel is the primary f uel

consumed in China with close to 125 million MT consumed in 2007. Pure gasoline consumption

was approximately 42 MMT in 2007. Both diesel and gasoline consumption in China have

increased substantially as China’s economy expands. Pure gasoline use has plateaued

somewhat over the last five years as gasohol (E10) consumption has grown. During this

timeframe, automobile use in China has increased on average 15 percent during 2003

- 2007

annually, according to China Energy Statistical Yearbook 2008.(Source: China Energy Statistical Yearbook 2008)