The World Trade Organization ruling has been three years in the making after Malaysia, the world's second-largest producer of palm oil after Indonesia, initiated the case in 2021.
Kuala Lumpur challenged EU measures limiting the eligibility of crop-based biofuels to count towards member states' renewable energy targets, and measures phasing out the eligibility of palm oil-based biofuels altogether by 2030.
Despite the WTO panel's decision, certain deficiencies were identified in how the EU's measures had been prepared, published and administered.
The panel's 348-page report was published on the WTO's website.
The dispute concerns the EU Renewable Energy Directive of 2018 (RED II).
Malaysia had requested an arbitration panel, charging that the EU, and in particular member states France and Lithuania, had imposed restrictive measures on the use of palm oil in ways that violate international trade agreements.
Brussels blocked the initial demand for a panel, but the second request was granted.
"Malaysia has failed to establish" that certain measures brought in under RED II "are inconsistent with the obligation... to ensure that technical regulations are not more trade-restrictive than necessary to fulfil a legitimate objective", the panel concluded.
The EU has deemed that palm oil production is not sustainable, and that palm oil-based biofuels cannot be counted towards EU renewable targets.
Palm oil is a key ingredient in a wide range of products from food to cosmetics.
But environmentalists say it drives deforestation, with huge swathes of rainforest logged in recent decades to make way for plantations.
Its use in food and cosmetics has already dropped in Europe, partly due to pressure from green groups on major corporations, but has been increasing in biofuels.
Indonesia has filed a separate palm oil case against the EU at the WTO, which is still pending.
Indonesia and Malaysia together account for most of the world's production of palm oil and palm oil-based biofuel.
The two countries requested WTO dispute consultations with the EU, charging that the measures in question were inconsistent with a number of provisions under WTO agreements.
They also challenged a French tax measure introduced to meet the EU renewable energy targets.
In addition, Malaysia challenged a law on renewable energy in Lithuania, which was amended to reflect the revised EU rules.
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