The proposed blend for local consumption is 5 percent palm oil to 95 percent diesel. Officials said Malaysia could reduce about 500,000 tonnes of diesel imports a year this way.

Global demand for green fuels was 2.5 million tonnes last year and was expected to expand 25 percent a year, Abdullah said.

"Considering this potential, the government is going to produce biofuel in a big way ... particularly for Europe."

Last month, the government raised pump prices for the fourth time in eight months to cut back on fuel subsidies, estimated to cost 14.48 billion ringgit ($3.87 billion) this year.

Malaysia consumes up to 190,000 barrels of diesel and gas oil per day and it exports about 86 percent of the roughly 14 million tonnes of palm oil it produces a year.

Officials said palm oil, at 1,300 ringgit a tonne, cost about a third less than diesel, priced up to 2,000 ringgit per tonne.

CHEAPER, CLEANER

Biofuels are taking on renewed global importance as countries seek to cut environmentally hazardous emissions.

Malaysia is a net exporter of oil and gas but because of the subsidies, surging global oil prices are draining state coffers, which Abdullah said would get a boost from biofuel exports.

"As it is, biofuel from palm is as an energy source for transportation and industry in several EU countries," Abdullah said, adding that German trains are powered with biofuel and electricity plants use palm derivative stearin for fuel.

He said Malaysia would build a plant to test palm diesel for use in cold climates and a quality standard for the EU market would be established before exports begin.

"This standard is important. We want to come out with it before anyone else does."

Some Malaysian firms such as IOI Corp and Kuok Oil & Grains have already started building refineries in Europe to process the additional palm oil expected to land in that market for biofuel manufacturing purposes.

ENERGY ALTERNATIVES

Palm oil's emergence into the biofuel market comes decades after the introduction fo ethanol, made from sugar cane, and other additives.

Rapeseed oil now makes up between 80 and 85 percent of the biodiesel produced by the EU, with soybean oil and a marginal quantity of palm oil accounting for the rest.

"We may be the new kid on the biofuel block, but the demand from Europe itself will keep palm diesel going strong against any other rival," said S.J. Dhass, marketing manager at Bell Group, operator of Malaysia's largest private palm oil mill.

The EU imports about 3.5 million tonnes of refined and crude palm oil every year, chiefly from Malaysia and Indonesia, and could supply up to a fifth of EU biodiesel demand by 2010, Fediol, a vegetable oils trade organisation, said in May.

Fediol data shows that total biodiesel output by the 15 Western EU members rose to an estimated 1.85 million tonnes last year, from 1.45 million in 2003 and 1.05 million tonnes in 2002.