* Parliament votes to raise 5 pct cap proposed by Commission
* Limit would still hurt crop-based biofuel producers
* Rules must still be jointly finalised with EU governments
By Claire Davenport
STRASBOURG, Sept 11 (Reuters) - The European Parliament has voted to limit the use of fuels made from food crops because of fears that biofuels can push up grain prices or damage the climate, further undermining the once booming industry.
Lawmakers voting in Strasbourg on Wednesday set a ceiling on the use of such fuels at 6 percent of overall transport fuel demand in the European Union in 2020.
Although slightly higher than the 5 percent cap proposed by the European Commission in October, it deals a blow to EU biofuel producers by effectively preventing them from increasing current output.
In 2009, the bloc set a target for a 10 percent share of renewable energy in transport, with almost all of it to come from so-called first generation crop-based fuels.
Biofuels, such as ethanol made from sugar or biodiesel from rapeseed, are blended with conventional transport fuels and added to vehicle fuel tanks. They were originally intended to reduce transport carbon emissions and cut Europe's dependence on imported oil.
But faced with claims that Europe's thirst for biofuels was driving up global food prices, and scientific evidence that some biofuels are more harmful to the climate than even conventional fossil fuels, the Commission was forced into a rethink.
"We can't stick with a policy that has such a negative effect on the countries of the south and on food prices. At the end of the day, the parliament has voted in favour of an acceptable limit," French Liberal MEP Corrine Lepage, who led the parliamentary debate, said after the vote.
With first generation biofuel consumption already at around 5 percent of total EU transport demand, and with almost enough installed production capacity meet the 10 percent target, a limit of 5 or 6 percent would call time on the once booming industry and force some existing plants to close.
Lawmakers backed an amendment that would force energy companies from 2020 to take account of the indirect emissions caused by crop-based biofuels, which increase overall demand for land and, as a result, encourage rainforest clearance or draining peatland.
That would effectively ban the use of biodiesel from oil crops such as rapeseed, palm and soy, which according to the EU's scientific models are more damaging than conventional diesel when their overall impact on the environment is taken into account.
The biodiesel industry says the scientific models used in the studies are highly uncertain and based on flawed assumptions.
In order to try to make up the shortfall created by the cap on first-generation fuels, the parliament said the EU should set a new 2.5 percent sub-target for the use of advanced, non-crop fuels made from algae or agricultural waste in 2020.
A coalition of industry and environmental groups - including the European Climate Foundation and Danish advanced biofuel producer Dong Energy - have said that full sustainable use of agricultural and forestry waste could supply 13 percent of EU road transport fuel by 2020.
"This potential will only be realised if EU biofuel and related industries are given investment certainty and a stable policy framework by the European Parliament and Council," the group said in a statement.
One aspect of the vote that offered a glimmer of hope to the biofuel industry was that lawmakers demanded further talks about the rules before opening negotiations with EU countries to finalise them.
With EU governments yet to finalise their common position, talks on the proposals look likely to extend into next year. If they are not concluded by April, European Parliament elections scheduled for the following month could push back the law until 2015. (Writing by Charlie Dunmore, editing by Veronica Brown and William Hardy)