The Energy Report: New proposed Environmental Protection
Agency (EPA) requirements for the renewable fuel standards (RFS) program
could change the landscape for biofuels. What is the new supply-and-demand
picture for corn ethanol, biodiesel and sugarcane ethanol?
Brett Wong: This is a proposal, and not a confirmed mandate, which
we expect to get by the end of November. The two most important pieces in the
standards cover corn ethanol and biodiesel usage requirements. The new
proposal for minimum corn ethanol use would be 13.4 billion gallons (13.4
Bgal), which creates a floor. The blendwall, based on Energy Information
Administration's (EIA) expectations for gasoline consumption this year, is
about 14 Bgal based on 10% ethanol content in gas, which car manufacturers
say is a safe level for the fleet. That is the domestic ceiling. This leaves
discretionary blending from 13.4 up to 14 Bgal. Beyond that, the demand is
from exports, which use up the overall capacity of about 14.7 Bgal. Some people
talk about 15 Bgal, but I think that includes some facilities that will never
come back on line.
We send a good amount of our ethanol to Canada, which has blending
mandates as well. We send some to South America. Brazil has a large blend
requirement of 27.5%, which was an increase from 25% last year. That country
produces a lot of ethanol from sugarcane, but it has had some rough crop
years and must import biofuel to fulfill mandates. There are also more
exports going to Asia, where China is trying to clean up its air.
For biodiesel alone, we have about a 2.1 Bgal capacity in the U.S. The
mandate for 2015 has been proposed at 1.7 Bgal. This was a big improvement
from 1.28 Bgal in 2013. We've shown, in the last year, that the biodiesel
industry can absorb more gallons. The other 0.4 Bgal of capacity could be
made up through the increase in the "advanced" biofuel category,
which includes cellulosic ethanol, biomass-based diesel and sugarcane
ethanol. The advanced biofuel category is proposed at 2.9 Bgal for 2015; less
the biodiesel and cellulosic mandates, that leaves about 1.1 Bgal of
additional advanced biofuels that will need to be made up by sugarcane
ethanol imports or biodiesel. Cellulosic biofuels has its own mandate, but
it's very small because, so far, the industry has taken longer to develop
than anybody expected. I think it will continue to take a long time.
I believe that given the sugarcane ethanol industry in Brazil, we will see
very little sugarcane imported from Brazil. This means we will have to
satisfy the advanced biofuel mandate primarily from biomass-based diesel. We
could easily be in supply-and-demand equilibrium, even with European and
Argentine imports, because of the advanced biofuel piece, making biodiesel an
increasing opportunity.
Once the mandates are finalized, I believe we will see margin improvement
based on pickup in demand. The blending levels are still pretty small
compared to overall motor fuel consumption, for biodiesel specifically.
Blenders are the obligated parties mixing these biofuels with gasoline and
diesel. They can blend at the end of the year and still meet their
requirements, again for biodiesel specifically, because the volumes just
aren't that high.
TER: Brent Erickson, executive vice president of the industrial and
environmental section at the Biotechnology Industry Organization, said the
EPA proposal would chill investment in the sector, causing a $13.7 billion
shortfall in investments for advanced biofuel capacity. Do you agree with
that?
BW: I think this was a discussion around the expectations of the
National Biodiesel Board for the mandate. Although the proposals were below
what the National Biodiesel Board was projecting, I still think it is
positive. Investment activity should pick up over time as the industry
continues to grow. The advanced biofuel category overall is growing. That
could help spur growth in the biomass-based diesel industry.
The proposals came in below what the industry was expecting, but I still
think it is positive that we got an increased mandate. I also think it's
important that we got increased visibility across multiple years. Since the
RFS was put in place in 2007, we have seen one-year views. At the end of
2013, we didn't get any ruling from the EPA. The mandate is the key driving
force behind the biomass-based diesel industry, so that silence created a lot
of uncertainty.
Ethanol can compete with petroleum products even without the mandates, but
biomass-based diesel is not economical to produce compared to diesel. That
makes policy an important driver in the industry. The multiple-year guidance
is important because it removes some of the overhang around the regulatory
aspect and shows confidence that there's support for growing the industry.
TER: Renewable fuels are a small part of the gas price. So when gas
prices overall go down, is that good for renewables because people might use
more gas?
BW: Yes. You do see a pickup in demand when you have lower energy
prices. This year was proof. Energy prices were cut in half. Ultimately, that
has led to an increase in consumption. The EIA projects that 2015 consumption
will be two to three points above 2014 levels.
But at the same time, when you have a significant price reduction, that
impacts producer margins negatively. What we've seen in the industry so far
this year is that the lower energy price has had more of a negative impact on
producers than the positive demand response from lower prices.
TER: There are always winners and losers in both market changes and
regulation changes. What specific companies will be the winners if these
requirements get adopted?
BW: Within biodiesel, if the industry plays out to my expectations
and we start to see margin improvement given increased demand for biodiesel,
then all the players benefit. Some of them are integrated producers like ADM
(ADM: NYSE) and Louis Dreyfus Commodities B.V. (private). Those are big
conglomerate companies, so biodiesel is a very small piece of what they do.
There are also pure-play independent producers, some of them public. FutureFuel
Corp. (FF:NYSE), which produces biodiesel from soybean oil, beef tallow
and pork lard, will benefit. In my view, the one that will benefit the most
is Renewable
Energy Group Inc. (REGI:NASDAQ). It is the leading producer and one of
the lower-cost producers. Renewable Energy Group could be the biggest winner
within the nonintegrated providers.
TER: Renewable Energy just acquired Imperium Renewables Inc. How
will the addition of a biomass diesel refinery with a 100-million-gallon
capacity impact the company's prospects for the rest of this year and into
next year?
BW: The ribbon cutting just happened in Grays Harbor, Washington.
That was an interesting acquisition because Renewable Energy acquired those
assets for a discounted valuation compared to replacement costs. The
replacement value for a low-cost flexible feedstock facility is typically
$1/gallon, and the purchase price was a third of that.
In addition to the facility, Renewable Energy also acquired an export
opportunity and West Coast operational diversification. It provides an
opportunity to play in the California market, which has low carbon credit
standards. This moves total capacity for the company up from 332 million
gallons (332 Mgal) to 432 Mgal, a significant 30% increase.
TER: Are there catalysts for Renewable Energy Group?
BW: Depressed energy prices are hurting a lot of the energy players.
The macroeconomic cycle in energy is going to be important. But even without
a turnaround in the energy construct, the biodiesel industry works because it
is mandated by the government. As long as we get positive policy enforcement,
the industry will work, and that will boost Renewable Energy Group.
I am also watching Renewable Identification Number (RIN) prices, which the
EPA uses to make sure blenders are meeting its compliance requirements. RIN
values are not traded on an open market, so they're pretty illiquid and can
be difficult to track at times. I watch RINs, and if they start improving,
that suggests biodiesel demand is also improving, even if biodiesel prices
don't move. That could lead to an overall increase in the average selling
price for products from Renewable Energy Group and all the other biodiesel
producers.
A potential return of the blenders' tax credits—a subsidy to blenders
using biodiesel—provides a nice opportunity for operators because they get
some of that credit. It provides a cash infusion so these companies can pay
down debt, improve their balance sheets, maybe even allocate some cash to
shareholders and continue growth. Renewable Energy Group's Grays Harbor
acquisition is an example of this.
TER: You mentioned FutureFuel. Darling
Ingredients Inc. (DAR:NYSE) is also in the biodiesel sector in the fats
and greases area. Do they fulfill a different part of the demand than a
company like Renewable Energy Group?
BW: FutureFuel's facility and the Diamond Green facility, which is
a joint venture between Valero Energy Corp. (VLO:NYSE) and Darling, are all
playing within the same market. The Valero/Darling facility is technically
renewable diesel, similar to Renewable Energy's recent acquisition in
Geismer, Louisiana. It's a different process and a different product, but for
the most part, they are all operating in the same industry. All of those
providers use low-cost, flexible feedstock operations.
TER: Based on the market picture you have painted, what advice do
you have for investors just getting involved in the renewable fuels sector?
BW: You have to have a strong stomach. The renewable fuels industry
has historically been governed by policy, which means things can change very
rapidly, especially when administrations change. The regulatory piece will
always create an overhang for biodiesel specifically, and for renewable
energy in general.
But biodiesel also provides a really nice opportunity at the moment
because of the potential for regulations to increase demand. I expect to see
improvements on the margin front for biodiesel producers. Ethanol presents a
nice opportunity for investors looking for something not as tied to
regulation. Ethanol operates around supply-and-demand rather than policy.
Overall, now is probably a cautious time to be looking at investments
within biofuels just because of the current global energy construct. Biofuel
prices are by no means immune to energy prices. But within the group, I think
that biodiesel could come out a winner.
TER: Thank you for your time, Brett.
Brett
Wong is a vice president and senior research analyst at Piper Jaffray
covering agriculture and ag biotech companies. Prior to joining Piper Jaffray
in 2011, he worked as a capital project and process engineer in the ethanol
industry. Wong holds a bachelor's degree in chemical engineering with a focus
in biotechnology from Tufts University, and a master's degree in business
administration from the University of St. Thomas.
