Terrabon CEO Gary Luce says the biofuels industry must rethink the Renewable Fuel Standard, to create the stability for capital formation and prevail over a coalition of wealthy, entrenched opponents.
“Brace yourselves,” warned Renewable Fuels Association CEO Bob Dinneen in a keynote address this week at the Fuel Ethanol Workshops, noting the the looming battle over the Renewable Fuel Standard. “It will be brutal. We are going to have to be vigilant.”
But it is bound to be an unequal war, in terms of resources. As Terrabon CEO Gary Luce notes, “I watched the amount spent on the RFS2 debate, the obligated parties are spending orders of magnitude more on opposing RFS2 than any exposure they have because of capacity shortages. There is no way this small, start-up industry is going to match them in terms of spending, or other resources.”
The industry, in short, is going to have to consider what to do, when strategy is going to have to be based on a Doctrine of Underwhelming Force.
And a coalition is forming on the other side. Among them are traditional opponents of the Renewable Fuel Standard and biofuels. Others among them are newly recruited since the passage of the Bush-backed Energy Security and Independence Act in 2007.
Who are they? When it comes to renewable fuels, call them the Coalition of the Unwilling. Included amongst their ranks: obligated oil refining parties, Republicans who smell blood in the water, the Grocers Manufacturers Association, anti-tax groups, carbon skeptics, libertarians, chicken farmers and cattlemen, and the left wing of the environmentalist movement.
It’s the capital formation, stupid
“The issue is not the RFS, but capital formation,” asserts Terrabon’s Luce. “it’s about how to get debt and equity on these plants. The purpose of the RFS was to provide the stability that the market needed, that investors needed, in order to come forward with the $400 billion that will be needed to bring this industry forward.
“The RFS2 debate, itself is now becoming a factor in creating instability. It doesn’t matter whether that is right or wrong. What matters is that the debate itself is creating a large set of uncertainties in the minds of investors. With the technologies that are out there, and the costs they have at scale, we know that the policy will be stable if the capital can be formed, because the sector will be powered by the difference it is making – the way it has transformed the cost and supply chain for fuel, and the way it has transformed the value of feedstocks.
Equity won’t go the dance by itself
“Equity is not really the issue, asserts Luce. “There is a lot of money on the sidelines available to work. We have got to build debt, it is really about debt formation. You need 40-50 percent debt on the early plants – and with debt it is all about the off-take contracts, and the protection from RFS2 sitting on top of those off take contracts. Later on, the debt component will be even higher as the technologies prove out, and the stability of RFS is confirmed.
“With debt investors, the question for them on RFS is real – “is this thing really going to go away, what is the time frame I can count on, to get the cash flows from this project to pay that debt down?”
“The market is going to clear on the equity side. But equity won’t go to the dance by itself.”
It’s technology today, capital tomorrow, and the next day, and the next day
“Companies in this sector are like snowflakes, they look a lot alike, but when you get up close they are each unique,” Luce adds. “Some have issues with their technology, some don’t. But step one – does technology work. That’s just the first step of several. Can you get from point a to b in terms of technology – it’s critical – and so is reducing your scale-up risk, by using known processes where you can, using pots and pans, pumps and pipes, that exist in the market today, so that your investors can get comfortable with the engineering risk.
“But then, you are right back to capital formation. When everyone gets plant one done, we’ll see what works and does, then the consolidation begins, then the real scale-up financing – not scale-up of a technology, but scale-up of any industry, with the MLP market coming on and vehicles like that, 4 to 5 years down the road, after a company has done a plant or two.”
An alternative fuels policy, or an alternative feedstock policy?
“I watched the amount spent on the RFS2 debate,” says Luce, “and discussion in the Digest about whether the RFS is about an energy policy or an agricultural subsidy policy.
“One thing from a technology perspective, you have to be very clear about what the technology is enabling, what is better, faster or cheaper about what you do.
“We are not making a magic fuel; fuel is a commodity, in the end you have to compete on price. In our case, we are here because of how our technology allows a player like Waste Management, which has a balance sheet just as large as some of the obligated parties, to change how the wet waste market supply chain is working.
“That is how we are truly enabling value creation. And if you are not creating value, then it becomes a big science experiment, and you are trying to bring in $400 billion with all the risk profiles.
RFS – an obligation on whom, exactly?
I asked Luce if he thought that the RFS2, as structured, was in large part structured – especially with the fines for not blending fuels that were unavailable – in order to incentivize obligated parties to invest equity into the building of capacity, and he agreed that it was to some extent designed that way. But unsuccessfully designed.
“A tax on the refiner is, in the end, a tax on the public, any fines that are paid RFS2 are refolded into marketing cost so long as all refiners treated equal, and there’s no arbitrage there. It’s the public that is paying for it, and the question really has to come down to them – do they support the RFS and its goals or not. If you really want the refiner to invest, with the size of their balance sheets, you have to show a billion dollars to them, to make a real difference – a billion earned, or a billion lost to a competitor. One or two plants isn’t enough to make a difference.”
The RFS structure
I asked Luce if the RFS, as currently structured, was going to offer the Coalition of the Unwilling a free, “every January” opportunity to shout out “where are the gallons?” on cellulosic biofuels, and lobby Congress about the unfairness of paying fines for fuels that are not generally available on the marketplace. Regardless of whether those fuels are unavailable because – if you accept the theory – some obligated parties have done everything they possibly could to ensure that the fuels would never be available on the marketplace. Or because of the Great Recession and the 2008-10 credit crunch.
His view? “Doesn’t matter why there is instability. It might be that people are out there protecting their legacy assets, and I understand as someone out of the refining industry why they would want that. The issue is, time is our enemy, not theirs.
A Way Forward
“We can’t take a hard line,” Luce says, “and simply say the RFS is perfect. In 2005-06, no one thought about 2008 and the credit crash when this was designed, no one put in a method to rejigger the timelines, when the credit markets closed for 2-1/2 year. What is really important is not the mandate, but the RIN. You build the facility and bring it online, and if you build it, that you will get the RIN.
“If you can show that you have stable supply, stable off-take, and a stable RIN component. Then you can bring in debt. And if you have the debt, you can bring in the equity. It’s about a lot more than leaning on a loan guarantee or a strategic investor to take the risk on plant number one. That’s what you have to do, because you are not building a plant, you are supposed to be building a commercial model.”
Talking it Through
“What does it come down to?” we asked Luce. “It comes down to this. Can you get a group of industry leaders together and talk about it, and the problems, and put stability back into the policy? Forget the volumetrics, or just keep the end target, when a plant comes online, the RIN is there. In exchange – you push the numbers out.”
At the end of the day
“You have to have three things,” says Luce. “A, you have to be able to compete on price. B, you have to be able to attract commodity equity and debt. C, you have to have stability in the policy.”
The Digest’s Take
Focusing on the end goal, which is capital formation, is right. Thinking about extending the RFS2 out to 2030 is right, also – after all, debt issuers are likely to want to see 15-year RFS protection, anyway, for 15-year debt. Thinking in terms of alternative feedstocks, rather than alternative fuels – that’s interesting, isn’t it? Dropping the volumetric requirements for advanced biofuels, and simply giving a RIN for production – that’s highly interesting too. We surely agree that the industry will be out-gunned on every front if it simply goes it alone with some friends in aviation, and farmers and MSW aggregators.
The public, in the end, is going to have to understand, and support, the RFS – the case has to be represented to them. After all, can there enduringly be taxation without representation, in these United States?
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