(This is part of a series on renewable energy)

 

By Gerard Wynn and Muriel Boselli

 

LONDON/PARIS, March 6 (Reuters) - A global, government policy-fuelled rush to produce biofuels is backfiring as it pushes up costs and makes the environmentally-friendly alternative fuel far less competitive.

 

Made from plants, bioethanol and biodiesel emit fewer greenhouse gases than fossil fuels and have been hailed as an answer to both climate change and energy security. U.S. and European backing look to have secured their long-term future.

 

But in the near term a looming biofuels glut plus falling rival crude oil prices, down a fifth on last summer's highs, mean producers can less easily pass on their spiralling costs.

 

The present dip will last until demand rebounds, perhaps as far off as the end of the decade.

 

"The two key ingredients for a dynamic biofuel sector are sky-high crude prices and cheap feedstocks," said Raffaello Garofalo, head of the European Biodiesel Board (EBB).

 

European Union leaders are expected this week to agree a binding target for the 27-nation bloc to get a tenth of its transport fuels from biofuels by 2020.

 

Falling oil prices are hurting sales of biofuel which was barely competitive before, pricking European and U.S. europhia built on subsidies and ambitious targets.

 

Profits are still to be had but a continuing scramble for raw materials like corn, soy and wheat will knock margins as producers re-negotiate more pricey supply contracts.

 

Still thriving, however, is biofuels pioneer Brazil, which has a booming domestic market where more than two-thirds of all new cars can run on either gasoline or ethanol.

 

This contrasts with the United States and Europe, which are propping up their less mature industries.

 

U.S. President George W. Bush visits Brazil this week and the world's number two ethanol producer will lobby America, the number one, to end ethanol tariffs. Brazil has support from an unlikely quarter -- the International Energy Agency (IEA), energy adviser to 26 industrialised nations.

 

Fatih Birol, chief economist at the IEA told Reuters that the U.S. and Europe should scrap import duties on developing countries and in the longer term reconsider all subsidies.

 

SQUEEZE

 

Biofuels costs will likely fall and demand and prices rise in Europe and the U.S. as better infrastructure and economies of scale kick in over the next two to three years, analysts say.

 

U.S. Democrats last week proposed a $15 billion energy plan, including boosting the country's network of ethanol service stations, for example.

 

But biofuels future also depends on oil prices, and analysts cannot guarantee crude oil will stay above the $60-$65 where it is trading now and undercutting biofuels -- excluding subsidies -- outside Brazil, according to the IEA.

 

Another factor is input cost: but sugar, corn, grain and palm oil prices are all seen holding or rising in the near term.

 

A new generation of biofuels made from waste like straw and wood chips would ease input shortages, but is not expected to be commercially available before 2009 and possibly much later.

 

In the United States soaring demand is expected to beat farmers' efforts to keep up, with high corn prices likely in the near-term, not least after Bush in January asked Congress to back a near 5-fold increase in the use of biofuels by 2017.

 

Top palm oil producer Malaysia said in February most of its 86 approved biodiesel plant licences were unlikely to come on line in the next two to three years because of the price squeeze.

 

GLUT

 

The biofuels craze is risking a surplus in the United States and elsewhere.

 

Investors F&C, with 155 billion euros ($204.9 billion) under management, says it has exited investments including the second biggest U.S. ethanol producer VeraSun <VSE.N>, because of the prospective over-supply and margin squeeze.

 

A glut is also expected in parts of Europe, where biofuels support is switching from tax credits to blending targets, and notably Germany where higher taxes have knocked sales by as much as a third this year so far.

 

"In the very short-term we have far too much production capacity," said the EBB's Garofalo.

 

Elsewhere, Spanish energy firm Abengoa <ABG.MC> is mulling suspending output at its biggest ethanol plant, partly on higher grain prices and partly because the domestic market is saturated under present blending labelling rules.

 

Oil major Total <TOTF.PA> has put on hold a biodiesel project with Finnish refiner Neste Oil <NES1V.HE>, while prospective British ethanol producer Ensus postponed last December plans to list on London's Alternative Investment Market.