The Outlook for Renewable Fuels: The Top 10 issues for 2015

As spring 2015 approaches, what are the Top 10 issues of the year, what’s the progress for renewable fuels?

From time to time, the Digest gives updates on renewable fuels to investors and traders in the financial community, looking at trends and datasets, aimed at providing background and guidance for those who do not follow the sector on a daily basis.

Here’s our most recent update, focusing on 10 key issues (though not ranked in order of importance):

1. Oil price volatility — will it stabilize?

2. RIN price volatility — will the rollercoaster end?

3. Ethanol blend wall — what’s the work-around?

4. Policy and mandate stability — backbone, anyone?

5. Asia is the new Brazil — will Brazil surprise?

6. Chemicals, chemicals, chemicals – all they’re hyped to be?

7. Aviation advancing – or will airlines blink with low fuel prices?

8. M&A, consolidation – how much, how soon?

9. Loan guarantees, HNW, sovereign investment — will they materialize?

10. Cellulosic deployment — 2nd commercial plants?

Here are the detailed bullet points we have presented on each topic

Oil price volatility

What’s do low oil prices mean for industrial biotech?

• Less push-back on consumer fuel prices re: mandates, RINs
• Tough equity raising environment while market finds a bottom
• Perception that biofuels can’t compete with low prices
• Strengthens policy support for Renewable Fuel Standard on energy independence concerns, while distracting opponents
• Reduces upward presssure on farm prices — good news for feedstock costs for first-gen fuels

RIN price volatility

Why are RIN prices rising?

• D6 (corn ethanol) RINs price rise when gasoline demand strengthens relative to ethanol
• With gasoline prices falling faster than ethanol prices, there has been RIN pressure building as obligated parties begin to prefer gasoline
• Plus, there is resistance to ethanol blending because of reaching an E10 saturation point, and limited E15 or E85 infrastructure
• It’s exacerbated by the lack of any incentive under RFS to build fuel infrastructure, and CAFE standards more aimed at engine efficiency than alternative fuels.
• Why are RIN prices volatile?
• RIN markets act something like short selling. Obligated parties sell RINs for working capital and possibly profit (buying back at a lower price, later). But towards the end of the year there can be a RIN shortage, as obligated parties rush to cover short positions.

Ethanol blend wall

E10 saturation point

• US E10 saturation point is at hand.
• Though gasoline demand is rising at the moment (falling prices), the effect is slight, and temporary. Long-term trends towards electrification, tougher CAFE standards dictate falling gasoline demand.
• One mitigating factor; refiners need to market enough gasoline to match their minimum gasoline/diesel/jet ratios — longer-term, gasoline will trade at a steeper discount to diesel, or heavier cuts, to maintain equilibrium.
• Alternatives for ethanol producers are exports, and building overseas capacity.

E15 and higher blends

• There’s an infrastructure stand-off — building ethanol blender pumps is expensive and not cost-effective for ethanol producers. Meanwhile, oilcos face most of the same expense and have also the desire to protect marlet share.
• However, if ethanol mandates continue to rise, obligated parties will have to invest in infrastrcture to market required levels of fuel, otherwise RIN prices will spiral out of control. E15 is the more likely beneficiary than E85.

Policy stability

US mandates

• Renewable Fuel Standard lowered in 2014 over blend wall concerns, but proposed rule not yet finalized (?!) because of industry push-back on future of renewables, impact on investors who relied on RFS targets, consequences for farm prices.
• EPA has annoucned plans to finalize 2014 “soon” and 2015 and 2016 together, likely not until November. So there will be considerable policy uncertainty throughout 2015.
• Meanwhile, “advanced biofuels” manadtaes are not being increased despite ample production capacity for fears that it will trigger a flood of Brazilian ethanol imports.

EU and elsewhere

• EU mandates are firming, but lowered to around 5% — few blend wall concerns. but there are stiff barriers against imports.
• Elsewhere, there are spotty mandates and targets, but generally focus on domestic production.
• Brazil’s ethanol industry has been hard hit over gasoline subsidies, but these are now being phased out.

Asia is the new Brazil

Demand side

• With downturn in Brazilian ethanol industry (gasoline subsidies dampened demand, high sugar prices dampened supply), eyes turned to Asia.
• Strong interest in first-gen in SE Asia, cellulosic non-food feedstocks in China.
• Renewable diesel and jet fuel also in demand — lack of oil production is one issue; carbon is also a more popular concern in Asia due to dirtier air.

Supply side

• Cellulosic feedstocks are relatively ample — corn stover, tallow, industrial gases (China), palm waste (Indonesia, Malaysia), sugarcane bagasse (India) .
• The barriers are technology, technical readiness of solutions, and reluctance to build first-of-kind plants.
• Generally, demonstration-scale plants are being built in US and EU.

Chemicals, chemicals, chemicals

• With low natgas prices, oil refiners are cracking gas to make ethylene (instead of naphtha), which leaves the world short on naphtha, which is also used to make BDO. So, BDO technologies are emerging.
• Organic acids require oxygen, which is present in biomass but not petroleum, so markets for adipic acid, succinic acid, malic acid, acetic acid, DDDA and others are strong for renewables.
• Technologies for producing n-butanol and acetone are cost-competitive with even low-cost petroleum, so there are a number of companies aiming towards scale there. Also, potentially, isobutanol.

Aviation advancing

• Airlines demand drop-in, cost-competitve fuels, which are not yet available.
• Right now, blending is at “gesture” levels by selected airlines (1%-2%), appetite for these projects dropping with lower fuel prices.
• US Navy is financing 100 million gallons of capacity under Defense Producion Act, these will be “cost-competitive” with spring 2014 oil prices.
• Investmnt underway in low-cost cellulosic aviaiton fuels — Cathay Pacific, British Airways, Virgin are directly investing — not at scale until end of the decade excepting Navy program.
• First aviation-oriented natonal mandate (“gesture” levels, but a first) now in Italy

M&A, consolidation

Activity in 2014

• Strong M&A environment, multiple mergers (usually involving a distressed entity) as well as numerous acquisitions (usually an under-financed hot technology). LS9, Syntroleum, Cardia Bioplastics are examples.

Going forward

• The Digest sees sharply increased M&A activity especially with underperforming first-generation plants that can be improved with new technologies (e.g. higher yields, switch to higher-performing molecules).
• Players with strong balance sheets like Green Plains (GPRE) are seeking to diversify away from fuels to balance ethanol margin volatility and reduce share price volatility.

Loan guarantees, sovereign investment

• US is launching new wave of loan guarantees, with commitment to substantially increase ratio of biomass / biofuels projects.
• Obama Administration is launching Clean Energy Investment Initiative aimed at family offices, foundations and pension funds. More and more players will seek to add prominent offshore family corporations, initially for equity and later as deployment partners.
• Sovereign funds (Malaysia, Brazil, EU) being heavily deployed to accelerate biofuels / chemicals deployment.

Data Sets

Here are some charts and tables we typically present that strike us as offering insight into the forward growth in the sector, and illustrate economic drivers (or debunk myths). Poll results are from The Digest’s readers surveys.