Estimating the impact of vehicle modification costs on the demand for biofuels in Malaysia Scott Kennedy and Fatimah Ahamad Energy and Environment Program, Malaysia University of Science and Technology No. 17, Jln SS7/26, Block C, Kelana Square, Kelana Jaya, 47301 Petaling Jaya, Selangor, Malaysia E-mail (Kennedy): skennedy@must.edu.my The demand for oil palm-based biofuels is expected to increase rapidly in Malaysia over the next decade due to the country’s extensive cultivation of oil palm. Plans are currently under development to promote the use of biomass-based fuels (i.e., bioethanol, biodiesel and straight vegetable oil) as a replacement for petroleum-derived fuels in the transport, industrial and power sectors. Predicting the exact amount of future biofuel demand is complicated by uncertainties in biofuel cost and availability, blending ratios, and consumer acceptance of a new fuel, which may require retrofitting of existing engines and fuel delivery systems. This paper examines the influence that vehicle modi- fication cost and biofuel-blending ratio could have on consumer preference for either biomass- or petroleum-based fuels for the road transport sector. The analysis assumes that a consumer switches completely to a biofuel blend (including 100 % biofuel) whenever the price of the blend plus an amortized technology modification cost is equivalent to the price of the petroleum alternative. This indifference price for biofuel, which is unique for a given technology and blending ratio, is calcu- lated by estimating the technology modification cost for vegetable oil, biodiesel, and bioethanol for various vehicle types at different blending ratios. A biofuel demand curve is then constructed that shows the total quantity of biofuel demanded at different values of the pure biofuel price. At low blending ratios (5 % for biodiesel and vegetable oil, and 10 % for bioethanol) there are no modi- fication costs and the indifference price is only slightly lower than the petroleum price due to the lower volumetric energy content of the biofuels. At higher blends, the indifference price drops significantly for vegetable oil and bioethanol, requiring a more substantial subsidy in order to increase available demand. For biodiesel, the indifference price remains high due to low modifi- cation costs for all blend ratios. 1. Introduction The market for biofuels is growing rapidly, despite their apparent price premium compared to petroleum-based fu- els, due to a proactive approach by governments to achieve a measure of energy independence as well as a reduction in carbon emissions. Furthermore, the scarcity of fossil fuel supplies in the long term, concerns about air quality in urban environments, and economic support for local farming industries drive the current demand and research. Various targets have been set by independent and governmental panels for the use of biofuels. One ex- ample is the European Union Directive 2003/30/EC that promotes and sets targets for the use of biofuels in the transportation sector within member countries [EC, 2003]. In Malaysia there has been a nascent effort to promote domestic use of palm oil-derived biofuels in government fleets through the production of “Envodiesel”, a blend of 5 % refined palm oil with petroleum diesel [Loh, 2006]. The primary focus in Malaysia, however, has been toward the export of biofuels and not the domestic market. Despite the global increase in biofuel use, their contri- bution to total energy supply is very small. According to the IEA, liquid biofuels made up only 0.1 % of total en- ergy consumed by the transport sector globally in 2004 [IEA, 2007]. To realize a transition to a significantly higher market share, a number of challenges related to the technical suitability of the existing capital stock, fuel delivery infrastructure, feedstock supply security, market development, and the establishment of environmentally suitable harvesting methods must be overcome. All of these obstacles add some incremental cost to biofuels, par- ticularly during the transition period when the industry is growing from a small base. Transition costs, as well as high feedstock and production costs in some cases, in- crease the cost of biofuels relative to petroleum diesel such that some form of price support or subsidy is usually required to make them competitive. This paper will examine one category of these transition costs – that is, the cost of modifying existing engine and fuel system technology to switch from petroleum- to biomass-based fuels – and the impact that this cost has on the demand for biofuels in the Malaysian road trans- port sector. The vehicle modification cost, which is rela- tively minor in most cases, as will be described later, will be compensated for by a slight reduction in the retail price of the biofuel blend relative to the petroleum-based fuel. Energy for Sustainable Development • Volume XI No. 3 • September 2007 Articles 67