An obscure EPA ruling may change the economics of ethanol production, forever — who wins, who loses, what’s the investor’s bottom line?
Just before Christmas, the EPA issued a final rule, determining that ethanol made from grain sorghum at dry mill facilities qualifies as a Renewable Fuel under the Renewable Fuel Standard — and that “grain sorghum produced at dry mill facilities using specified forms of biogas for…process energy and…electricity, qualifies as an advanced biofuel under the RFS program.”
Pretty technical stuff, and buried in the (…Zzzz) Federal Register, to boot. Hardly knocking the fiscal cliff, Katy Perry, or ABC’s Rockin’ New Years Eve out of the headlines.
But it’s revolutionary for investors. Here’s why.
Savings on grain sorghum (milo) vs corn.
Right now, import costs for grain sorghum (as of Q4 2012) from Argentina – feasible for ethanol plants with access to deepwater ports – is running $0.90 per bushel less than corn.
A reference (100 million gallon) ethanol plant would require around 36 million bushels of sorghum, at full capacity. Savings vs corn? $33 million, or $0.33 per gallon.
Advanced Biofuels RINs
To qualify as an advanced biofuel, fuels have to be made from qualifying feedstocks and achieve a 50% reduction in greenhouse gas emissions compared to conventional fuels. To date, with next-gen capacity just now being built, the winners in qualifying for Advanced Biofuels RIN’s have been biodiesel plants and imported Brazilian ethanol.
Now, those RINs are worth $0.40 each, compared to a nominal $0.03 for a corn ethanol RIN. For a reference sized (100 million gallon) ethanol plant, the difference in value is around $37 million, or $0.37 per gallon.
Increased cost for biogas
Now, biogas isn’t as cheap as, say, natural gas or coal-fired power. For our reference plant, it runs around $13 million more. Now you can see why the switch-over from corn to sorghum/biogas only makes sense in the context of the EPA ruling on RINs. There simply wasn’t nearly as much upside to justify the time, money and aggravation in making the switch.
The Bottom line
For the reference plant in our example, the net benefit is currently at $57 million per plant, per year — pure operating cash flow. Or $0.57 per gallon.
It also makes the point that, as an investor, you should highly beware advisers who give you platitudes like “The RFS drives up corn usage.” It can. But RFS, as in this example, drives demand away — it is all a matter of plant siting, the logistics of power supply, and seeing — ahead of other investors — how multiple input sources impact a process that manufactures commodities (like DDGs or fuels) out of other commodities.
The Aemetis example
Aemetis (AMTX:OTC) operates a 60 mgy corn ethanol plant which imported milo from Argentina in Q4 2012 at a cost savings of about $0.90 per bushel under corn. They require approximately 22 million bushels per year at capacity, so the milo savings are more than $18 million per year.
Add $18 million to the $24 million per year AB RIN’s, subtract about $8 million for the increased cost of biogas, and the net increase in cash flow is about $34 million per year for the 60 mgy (former) corn ethanol plant operated by Aemetis.
As Aemetis CEO Eric McAfee outlined for shareholders in a conference call just before Christmas:
“[The] market disadvantage for corn ethanol facilities allowed Aemetis to acquire the 60 million gallon per year Keyes ethanol plant near Modesto, California. The plant originally cost $132 million to construct, and was acquired in July 2012 by Aemetis for only about $15 million in cash and approximately 11% of Aemetis fully diluted shares. On an actual cash cost basis for the investors in the Keyes plant, this transaction values Aemetis common stock at about $6 per share.
“Aemetis originally leased the Keyes plant in late 2009, and then retrofitted the plant to implement Aemetis design upgrades at a total cost of about $8 million. The plant was restarted in April 2011.”
Who else can benefit?
Not every ethanol plant in the world is going to be able to access these improved economic opportunities — just yet. For now, the advantage for Aemtis occurs because it is 40 miles from a deep water Pacific port, not a Midwest ethanol plant located 1,000 miles from the Gulf of Mexico (with transloading and rail costs).
For now, this EPA approval turns destination ethanol plants on the coasts into facilities with a significant cost advantage in milo/biogas Advanced Biofuels. It also puts some major attention on growers and developers of grain sorghum in the US – and Chromatin, for example, has been hard at work in that field.
Potential winners for now? The Aemetis project; Pacific Ethanol (60 mgy ethanol plant located in Stockton, CA); we also like the Pacific Ethanol plant in Boardman, OR (adjacent to Port Morrow, largest port on the Columbia River); the currently-shuttered Clatskanie plant in Oregon may also be a beneficiary.
Well, the risks are several. RFS2 is repealed or modified; corn prices sink materially below grain sorghum; biogas prices skyrocket. Ethanol prices collapse as overcapacity hits the ethanol blend wall. There are only a handful of public investment vehicles that are correspondingly advantaged in the new economics.
Getting in on Aemetis
Today, Aemetis is still traded over the counter – one reason you don’t (yet) find it in the Biofuels Digest Index basket of stocks.
However, in November, Aemetis retained one of the largest audit firms in the US, McGladrey, and completed audits to become a fully reporting public company in November 2012—and filed for a NASDAQ listing and is currently active in the NASDAQ listing process.
Due to the filing of the audits and quarterly financial statements, Aemetis has now received Blue Sky approval in approximately 40 states. The planned NASDAQ listing is expected to provide Blue Sky approval in all 50 states.
Category: The Business Case