Biodiesel on the march; REG reports record revenues for Q2

As REG reports record Q2 revenues, what’s the price, production, and feedstock outlook for the “here today, made at home, advanced biofuel”?

In Iowa, Renewable Energy Group announced revenue for the second quarter of $271.9 million, up 39 percent compared to Q2 2011, and second quarter earnings of $26.5 million, up 3% – based on production rising 30% to 43 million gallons and sales rising 63% to 54 million gallons.

The earnings announcement gives us an opportunity to look at the overall position of biodiesel as an advanced biofuel – after a first half of 2012 in which most observers were tuned intently on the commercialization story of next-gen biofuels and the struggles with rain and yields in the corn and sugarcane ethanol markets.

As is sometimes overlooked, the advanced biofuels pool in the US Renewable Fuel Standard is not only a qualifying pool for cellulosic biofuels – which have struggled to come to market in the projected volumes. It is also a qualifying pool for drop-in renewable diesel and for biodiesel.

For that reason, the National Biodiesel Board has rightly characterized biodiesel as the “here today advanced biofuel”.

So, let’s look at some data.

Price

With a loss of the biodiesel tax credit and a fall in RIN prices, the average price per gallon (including RIN value) stood at $5.03 per gallon, for REG. That’s down from $5.91 per gallon last year at this time.

That’s a heft premium, compared to gasoline, but there’s the increased mileage with diesel to take into account. Take for instance, the Jetta TDI. The regular, automatic (S6) Jetta running on gasoline gets 26 miles per gallon. The automatic (S6) Jetta TDI, which runs on diesel, nets 34 miles per gallon. The premium for B20 and gasoline is running at roughly 50 cents per gallon, based on wholesale prices – a 16.7 percent jump. But on a mileage basis, it is 10.3 cents per mile for B20 vs 11.5 cents per mile for gasoline – now, that’s excluding retail mark up and fuel taxes – but you get the idea. Even without the biodiesel tax credit, biodiesel works for drivers within the current market.

With the continued uncertainty over the US drought – and feedstock prices – the company is lowering its outlook on income in the second half of the year.

Production

REG is up strongly, 63 percent year on year. But the biodiesel pool itself is also expected to be up strongly, with mandated production under the Renewable Fuel Standard set for 1 billion gallons this year, up from 800 million gallons last year.

The future. The National Biodiesel Board is suggesting, and REG is supportive, that the industry can continue to grow its production 200-300 million gallons per year. Stretched out over 10 years, that would bring biodiesel’s contribution to the overall Renewable Fuel Standard to 3-4 billion gallons – and, because biodiesel gallons count for 1.5 ethanol-equivalent gallons (owing to the higher BTU value), that could account for 4.5 billion to 6 billion ethanol equivalent gallons.

Possible? Sure. It will depend a lot of the availability and price of feedstock. So let’s look at that.

Feedstock

The industry has moved far along from its roots as an added-value market for soybean oil. It continues to provide an outlet for soybeans, but fully 80 percent of REG production comes from waste fats, oils and greases.

In the case of REG, a typical plant acquisition involves a conversion from soybean oil as a feedstock to a multi-feedstock approach – that’s what is taking place, for example, with the company’s newly-acquired Albert Lea facility, which has a capacity of 50 million.

“The vegoil facilities have a good middle refinery,” REG CEO Dan Oh tells the Digest. “What we do is put in a range of front end and back end technologies to handle other feedstocks and fine-tune the biodiesel we produce.”

“The largest source growth has been in inedible corn oil, coming from ethanol plants,” Oh added. “We expect inedible corn oil extraction to grow, and we also see that the high demand for low carbon materials is causing better extraction systems going in place – for cities extracting or recycling grease, for example, or companies recovering fats and oils.”

Looking at the industry: RFS2 and certainty

“RFS2 is fundamental to our industry,” Oh noted. “It took a long time to get in place. What we do need is more predictable guidance, especially in the known growth requirements in RFS2, otherwise we see a slowdown in buying behavior.”

Looking at REG: RFS2 and certainty

That slowdown and uncertainty causes angst amongst shareholders and analysts that own or follow REG.  In  looking at the company’s short-term share prospects, following the earnings announcement, Piper Jaffray’s Michael Cox wrote:

“Despite a strong 2Q, the uncertainty of the renewable volume obligation timing and increased pressure on margins should be headwinds for Renewable Energy Group in the back half of 2012 and into 2013. Demand for biodiesel is down because the 2013 RVO [Renewable Volume Obligation – the blending percentage required of diesel producers] is unknown…not expected to be announced until Nov..and even that time frame is uncertain. Margins are contracting without a higher RVO to offset lower biodiesel demand and RINs pricing is dropping faster than improvements in feedstock costs.”

Nevertheless, Piper, in redrawing its price target at $9, continued to maintain its Overweight rating in light of the company’s trading price of $4.70, and upside for the business once renewable fuel targets are set by EPA for 2013.

On RFS2’s future – and the US drought?

“RFS2 is working, and needs to defended vigorously,” Oh said. “If you think about it in aggregate, its created a food reserve in the country. It’s caused, for example, the drought to be a price problem here in the US, not a food scarcity problem. If we were starting at 1996 crop planting levels – with the kind of market that we had back then – we’d be looking at far more serious numbers in terms of food security.

“What are we getting? We are getting food security aspect we wanted, and more fuel security, and some wonderful environmental benefits. The problems of the drought are really serious, but they are temporal. If we didn’t have the demand, the problems would be far more severe.”