The Big Move: The leap from first-gen to next-gen biofuels companies, how does it happen?

February 8, 2015 |

green-plainsHow does the biofuels industry move from its roots in first-gen corn starch or cane sugar fermentation towards diversified products, more capacity and distribution, and new inputs like cellulosics?

How are the economics now — and where is the market headed?

Green Plains CEO Todd Becker — in speaking to analysts last week after annoucing record income — gives some clues as to how the future may unfold.

You might be surprised to learn that some among the major ethanol producers are openly discussing with investors and analysts how they might look at a post-RFS world, where ethanol competed head-to-head with fossil gasoline without the benefits of a mandate.

“An RFS repeal? Not something we see has a high probability right now,” said Green Plains CEO Todd Becker to analysts on Friday, “and obviously we’d like the Administration to provide some certainty.”

“But, eventually, the industry has to operate on its own and compete with oil. With a 30 cent discount and good cash flow we see the right fundamentals [now]. And in the countries we are hearing from regarding exports we are not hearing that they are looking for mandates.”

What’s the outlook on the RFS mandates for 2014?

“Well, we’ve heard that the EPA has sent the 2014 propsoal to the White House, and there are abundant rumors that they are looking at setting the mandate at the actial 2014 production

What’s the situation for corn, in the longer-term?

“Long term, corn has to compete at a BTU equivalent price,” Becker said. “It’s not good to have $4.25 corn in this market, but when you see it drop in to $3 something range, now corn prices in as a BTU substitute and even at even money to gasoline, ethanol is still the cheapest oxygenate [refiners can buy]. And the economics we see still offer farmers plenty of good reason to plant corn.”

Where is ethanol right now?

“We’ve obviously seen an adjustment [in oil prices], but we’re seeing some stability emerge with gasoline now around $1.75 and ethanol at something like a 35 cent discount,” Becker noted.

“Even at even momey to gasoline we don’t think [refiners] will back ethanol out of the blend and we are continuing to receive substantial export queries.

What about mandates?

“The mandate for 2015 is [targeted at] 15 billion gallons, but we’re waiting to see what EPA does.”

Are higher RIN prices driving more ethanol into the market via higher ethanol blends?

“We don’t see E85 as a great driver of volume, though we know that there are companies out there who are passing along the full value of the RIN to consumrs and can make money with sub $1.00 E85. But mostly we see E85 priced at only a slight discount to E15, so we see E15 as more of a driver. If the EPA keeps the hammer on obligated parties we’ll see more of the expanded blends.

What about E15’s prospects?

“We’re staring to see the same early movers on E15 that we saw when we went to E10. But right now all of them are looking at a $0.35 discount on ethanol relative to gasoline, and the benefit of a $0.70 RIN, that’s a positive driver.

Can ethanol make money at $1.40?

“The economics we see still offer farmers plenty of good reason to plant corn, and clearly we are reporting record income this quarter.

What’s the ethanol outlook in the next few years?

“For the next 5 years ethanol demand will exceed ethanol supply in our view but there will be times of margin compression. Right now, the opportunity is there for more capacity, we see an extra 100 million gallons that we can biold at less than $0.75 per gallon on brownfield sites, and there’s no [EPA] pathway approval required.

So, is that what Green Plains will focus on — adding ethanol capacity?

We like the earning potential of ethanol, balanced with continued diversification, and for the last 7 years we’ve been patient and opportunistic. But we’ve appointed a chief development officer, we might look at opportunities in energy and agriculture such as protein or industrial oils.

Where are those diversification opportunities?

“We see opporunities in the 5-10X EBITDA range,” said Becker, “and there’s competition out there, and obviously we’re less interested in the high end, but we believe there are opportunities out there in the 6-8X range. We’re not looking for fixer uppers. We’re looking at different product lines, for example an ingredients business, or grain processing, where we get more stable predictible cash flows, and a lower Beta [for the stock].

What about capital investment?

“We have $85M in our capex budget of which $20M is maintenance projects,” Becker notes, “the rest aimed at improving capacity, or projects like grain storage.”

The Bottom Line

Above all, don’t just think next-gen technologies. Think next-gen companies.

For now, Becker is confident that the current RIN and RFS system has the potential to drive E15 adoption, and push the blend wall back — and potentially drive some E85 or higher-blend distribution through the substantial discount ot gasoline for E85.

Longer-term, the combination of export markets and the strength of cost-competitive ethanol as a gasoline substitute, he thinks, will contimnue to push up ethanol demand over ethanol supply.

Interesting, of course, to see the dynamics of ethaol evolving — that the market for cellulosics that could be provided by E15 and E85 will be primarily driven in the short term by the opportunities that obligated parties see with the combination of low-cost corn ethanol and RINs.

In other words, there might well be a gteat deal of substance to the idea that first-generation ethanol has not only generated the grower-producer complex that will begin to support cellulosic fuels made from corn stover — it might also drive over the next 2-3 years the creation of a distribution option to get E15- blends of cellulosic fuels into the marketplace.

Meanwhile, if companies like Green Plains can continue to diversify their revenue streams, reduce stock price volatility and prove more attractive to long-term investors at higher and more stable prices — that may well drive a reduction in the cost of capital needed to fund the deployment of the next genration of technology.

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