On a sunny, spring morning on the banks of Lake Saimaa, it is easy to forget how cold it can get in Finland. “Everything has to be prepared for -40C,” says Teemu Lindberg, conducting final tests at a new biorefinery in Lappeenranta, a lakeside resort 20 miles from the Russian border. There is extra pressure on him to check every last rivet as the refinery will be the first of its kind when it starts operations this summer. Built by the paper company UPM, the €150m plant will use new technology to produce biodiesel, refining the treacly residue that is left over when wood chips are cooked into pulp.

The Finns are careful not to give away too many secrets of wood-based biodiesel, potentially revolutionary energy know-how for a country 68pc covered in forest. “That’s where the magic happens,” says Mr Lindberg, a director at UPM Biofuels, surveying the 40km of pipes that make up his refinery.

UPM is one of a handful of companies that devised technologies to make biofuels from waste after the EU mapped out rigorous new regulations for cleaner transport fuels in 2009. In addition to helping the environment, the policies were designed to give Europe a competitive edge in the clean energy business.

But instead of promoting the take-up of waste-based biofuels, policy makers in Brussels are now sidelining rules on transport fuels and could dramatically dilute the 2009 regulations. The biofuels companies and environmentalists say the EU’s backtracking is threatening to strangle the waste-to-biofuels industry in its infancy, forcing fledgling businesses to think about leaving for the US, China and Brazil.

Over recent years, biofuel has become a dirty word. This is because so-called first-generation biofuels derived from corn, sugar and palm oil are blamed for skewing commodity markets by using up land that should be growing food. UPM and others argue that Europe should instead pursue advanced biofuels made from waste. This means processing husks, inedible grasses, municipal waste and the litter from the logging industry.

Policy makers have traditionally been sceptical about fuels from waste, saying that they need big subsidies and could never produce significant volumes. But a fightback is under way, led by industry and non-governmental organisations.

In research published in February, the International Council on Clean Transportation and NNFCC, a consultancy, concluded that biofuels made from waste could provide 16pc of Europe’s transport fuels by 2030. This would create an entirely new sector as current production is close to zero.

The European Commission in 2009 proposed targets for reducing transport emissions in its landmark energy goals for 2020. According to Brussels’ directives, 10pc of transport fuel was meant to come from renewables and the transport sector was supposed to cut emissions by 6pc from 2010 levels. On the back of that regulatory framework, European companies increased their investments. In Denmark, Novozymes has become a leader in developing enzymes to break down waste. In Italy, Biochemtex has built a €150m biorefinery. In the UK, the government has dedicated £25m to demonstration plants for advanced biofuels.

But after five years of financial crisis, the focus in Brussels is shifting from the environment to fostering an ‘industrial renaissance’ to revive competitiveness. To the fury of green groups, the commission in January left out specific fuel targets when charting its energy goals for 2030. The package of goals for 2030 must now be approved by October but the surprising absence of fuel targets is a big blow for investment. Companies say they want to invest to improve the efficiency of advanced biofuels but their projects are now caught in a limbo; banks are unwilling to support new capacity because the EU is no longer setting a regulatory framework beyond 2020.

UPM has been awarded a grant of €170m to work on a solid biomass refinery in Strasbourg but is holding back because of the EU policy uncertainty. Another Finnish company, Vapo, also suspended a big biodiesel project in February because of the regulatory climate.

Some environmentalists say that the EU’s increasing fixation with the US explains its reluctance to propose new fuel quality rules. Both Canada and the US have lobbied hard for Brussels to weaken its fuel regulations as they represent a barrier to importing high-polluting tar sands. (While tar sands are extracted in Canada, they are refined in the US.) Green groups accuse Brussels of having buckled to pressure from across the Atlantic to secure trade accords with both North American countries.

But inside the commission, the 2030 fuel targets are seen as more of a logistical headache. EU nations have struggled unsuccessfully to agree how the 2020 goal of producing 10pc of fuel from renewables should be divided between first-generation and advanced producers. The Poles, for example, do not want the role of corn-based fuels to be sidelined. Until there is agreement on 2020, officials in Brussels say there is little hope of blending mandates for 2030.

One senior commission official explained that the priority for 2030 was to set an overarching goal of reducing greenhouse gas emissions by 40 per cent from 1990 levels. It was then up to individual countries to determine how they would meet that goal, so they were at liberty to build biorefineries if they wanted to cut emissions that way. “We are setting the direction of travel. The countries are free to decide how to get there. They have to do all this any way.”

The companies argue that one overall binding target is insufficient and that only specific EU mandates on blending fossil fuel with biodiesel will create a continent-wide framework and calm nerves among bankers, fuel distributors and motorists.

Even at the early stage, the technology is working. UPM has tested its fuel from Lappeenranta - as 20 parts biodiesel to 80 parts fossil diesel - in a fleet of Volkswagen Golfs that were driven more than 20,000km. The road tests were successful and the company ultimately plans to ramp up annual capacity at the lakeside biorefinery to 100,000 tonnes of biodiesel. The fuel is 80pc cleaner in terms of emissions than fossil diesel.

But the company insists this refinery is just a starting place and that the technology has much further to go. In the case of wood-based biodiesels, the next step is to move from liquid fuel to solid. Using the viscous residue from papermaking is significantly more expensive than producing regular diesel. But UPM sees it as a step to making diesel from solid waste such as branches, bark and sawdust, which would be cheaper.

The argument over advanced biofuels is based on prices as well as regulations. Companies are keen to point out that biofuels will create tens of thousands of jobs in poor rural areas and will help slice Europe’s imports of crude oil.

But there is no escaping the cost problems. The International Energy Agency puts the production price of advanced biodiesel at more than twice that of regular fossil motor fuel.

UPM admits it is unusual in making its refinery investment without subsidies. Most experts say that companies will need initial support, either with research costs or with duty discounts on fuel prices. The European Investment Bank supported Biochemtex’s research with a €65m loan.

But there is a growing consensus that the costs are set to fall in the coming years as the advanced biofuel business increases the scale of production. The IEA calculates that the cost of producing regular gasoline will rise from $0.54 per litre of gasoline equivalent in 2010 to $0.82 per lge in 2030. By contrast, the cost of advanced biofuel production will fall from $1.05-$1.15 per lge in 2010 to $0.80-$1 in 2030. The two could reach a parity of about $0.85 per lge in 2050. “You need to have a kick-start with subsidies but it is definitely competitive against fossil fuels in the long run,” says Petri Kukkonen, vice-president at UPM Biofuels.

While smaller companies are leading the innovation, oil majors have expressed an interest in moving into advanced biofuels. Airlines are also following developments closely as they face increasing pressure to cut emissions.

Peder Holk Nielsen, chief executive of Novozymes, insists that the nascent advanced biofuels industry “was asking for blending mandates, not subsidies. This game is going to be played over the next 10 to 15 years. If Europe does not embrace this, then it will happen in countries such as Brazil, China and the US”.