Did the EPA Just Kill Biofuels?

The Environmental Protection Agency last week announced a proposal to reduce mandatory volume obligations, or the amount of biofuels that must be blended or sold into the nation's fuel supply, for 2014. This would mark the first time the agency has scaled back its ambitions since the current Renewable Fuel Standard, or RFS, was announced in 2007. While it makes sense to reduce first-generation ethanol volumes, the agency's plans for cutting or freezing other fuel volumes are highly questionable.

Refiners such as Valero (NYSE: VLO  ) will enjoy the stability the proposed ethanol blending requirements will bring to the Renewable Identification Number, or RIN, markets, especially considering next year's targets are well below the industry's capacity. That's very bad news for producers such as POET, Green Plains Renewable Energy (NASDAQ: GPRE  ) , and Archer Daniels Midland, however. Meanwhile, freezing biodiesel volumes for the next two years will also bring uncertainty to high-growth producers such as Renewable Energy Group (NASDAQ: REGI  ) and Darling International (NYSE: DAR  ) . Let's go fuel by fuel and dissect what the proposals mean for the industry and your investments.

At a glance
The proposal for 2014 calls for the following volumes of renewable fuels:

Source: EPA

To put the proposed cuts in perspective, consider that the RFS originally called for about 18.15 billion gallons of renewable fuel in 2014. Most of the reduction comes from corn ethanol, which has a target of 11.73 billion gallons for next year -- much lower than the 13.8 billion that will be produced this year. Advanced biofuels, which include isobutanol, electric vehicles, compressed natural gas, and hydrogen, will be slashed from the original goal of 3.75 billion gallons, while biomass-based diesel targets will be held at 2013 levels through 2015 if the mandate is finalized.

What it means for corn ethanol
The EPA has come back to reality to acknowledge that trends in rising fuel economy and declining fuel consumption don't quite jive with the first-generation ethanol mandates it set back in 2007. The Blend Wall, or the 10% blending ratio limit for gasoline, was cited as the main reason for the reduction -- something the refining industry has been trying to bring attention to for years. Unfortunately, it doesn't take much skill to see that our transportation system cannot support large volumes of better, more efficient, and more sustainable fuels in addition to 12 billion gallons of corn ethanol each year. The numbers simply don't work.

While ethanol producers had sharp words for the proposal, reductions are necessary and are far from over. Expect to see smaller producers squeezed out of the market, while larger producers idle facilities. Extra capacity could spur the E85 market, but it will be difficult to dump an extra 2 billion gallons of ethanol anywhere. The ultimate EPA goal should be to transition away from first-generation corn ethanol and to more sustainable next-generation ethanol and nonethanol blend stocks. That's easier said than done, and cellulosic technology has some hurdles to overcome, but we can't make room for both.

What it means for cellulosic ethanol
Cellulosic ethanol has been "X years away" for the last decade. There is real progress being made on multiple fronts, however. KiOR has pioneered a novel thermocatalytic process at its first commercial scale facility, while POET-DSM is bringing Project Liberty online in early 2014 to advance fermentation technologies. Several more promising futuristic projects are being funded by energy giant Total and expected to make substantial contributions by the end of the decade.

At the end of the day, however, the capacity just isn't there, which makes the low targets understandable. The EPA can't mandate that refiners blend fuel that doesn't exist and penalize them when they don't. Well, hopefully not anymore.

What it means for biodiesel
The proposed freezing of targets for biodiesel makes absolutely no sense. What do you expect from an agency that was this slow to react to the long-foreseen problems with ethanol volumes, though? Unlike ethanol, biodiesel is nowhere near the boogeyman Blend Wall. In fact, there is no accepted national blend percentage for the fuel, although the current blend of 1.16% has a very long way to go before reaching the theoretical limit of 7%.

Darling and Valero's new Diamond Green Diesel joint venture started operations at this 137 mmgy facility. How will the proposed targets affect the JV? Source: Darling International.

The proposal is quite the head-scratcher given the differences between the diesel and gasoline supply and explosion in capacity from Renewable Energy Group and Darling. The two companies alone are set to add more than 285 million gallons of annual capacity between this year and 2015. I'd expect the agency to revise its proposal for biodiesel volumes upward before finalizing 2014 mandates. Unfortunately, the increase may not be the 200 million gallon advance the industry has come to expect in the last six years.

What is means for advanced biofuels
Once again, the new targets make little sense for the heterogeneous category called advanced biofuels. The proposal is probably more realistic given market conditions. But if the major problem with fuel volumes is the dreaded ethanol Blend Wall and advanced biofuels are completely separate from gasoline blends, why reduce targets for the category? Since most technologies have yet to be implemented on a large scale and are being developed to be competitive without subsidies, there shouldn't be many consequences for the new targets, anyway.

Foolish last word
It appears that the EPA has yet to learn its lesson on the realities of the fuel market and has instead chosen to make knee-jerk, last-minute reactions. If I were the agency I would take this opportunity to slash corn ethanol mandates to address concerns about the Blend Wall, while simultaneously pushing next-generation fuels. Subsidies could be shifted away from corn ethanol and into less established technologies. The industry will surely respond in full force to the proposal before the agency reviews and finalizes 2014 targets. At this point, however, how much faith can we have that it will get it right?

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Read/Post Comments (14) | Recommend This Article (7)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 19, 2013, at 9:51 AM, innov8r wrote:

    Maxx,

    Thanks again for your continued spot on coverage of these topics. EPA's lumping of ethanol and diesel together is clear evidence that they simply don't understand what they are doing.

    One clarification - the Darling/VLO project makes renewable diesel, not biodiesel. Renewable diesel is chemically interchangeable with petroleum diesel, so this product can move via conventional pipelines, etc. There is no blend wall for renewable diesel. Biodiesel has some blending limitations (depending on the composition), but, as you say, we are no where close to hitting them.

    The ethanol facilities that don't monetize their corn oil into the biodiesel market are going to be the first to feel the pain.

  • Report this Comment On November 19, 2013, at 10:40 AM, TMFBlacknGold wrote:

    @Innov8r,

    Ah, thanks for the clarification on Darling's product. My apologies for overlooking that.

    --Maxxwell

  • Report this Comment On November 19, 2013, at 12:01 PM, TXObjectivist75 wrote:

    Here's a thought, how about we stop letting an agency that doesn't know what it's doing mandate fuel production and blends? Then maybe sane markets can figure out what works best.

  • Report this Comment On November 19, 2013, at 12:09 PM, TMFBlacknGold wrote:

    @TXObjectivist75,

    While the EPA has implemented messy policy, the United States wouldn't sport the world's largest ethanol industry without the RFS. There's no debating that it has done exactly what it was established to do. However, the politicians who create such laws are rarely at the forefront of technological progress. Despite the hiccups I believe the EPA could still set us on the right course for introducing renewable fuels that are better than corn ethanol. It's just going to take some time and some painful decisions to get there.

    --Maxxwell

  • Report this Comment On November 19, 2013, at 2:16 PM, MWinMD wrote:

    TXObjectivist75 -

    Here's a thought, if you can find a way to price into regular fossil fuels their REAL cost, to cover the billions American taxpayers and consumers are paying each year to rebuild, adapt and otherwise recover from fossil fuel-driven climate change, so that the price at the pump PAYS for all of it, then I'll be more than happy to see us let "sane markets" determine what "works" best.

    We can start by removing the $41 billion in taxpayer subsidies we currently shovel each year to the oil and gas industries in return for shoving our civilization a little closer to the brink. Then we can start to price in all the negative externalities these dinosaur fuels are costing us.

    Back to the point of the article: it is frustrating that the EPA is being dreadfully slow in realizing what we have in biodiesel. Not only does it have none of the blendwall issues, it is also made increasingly from non-food waste products like used cooking oil and grease and animal fats, so we don't have the ILUC issues that ethanol suffers from. On top of that, its greenhouse gas profile is much more favorable than any of the other biofuels. And the US has unused capacity still. This should be a no-brainer.

  • Report this Comment On November 19, 2013, at 3:58 PM, NePetes wrote:

    The author wrote "Subsidies could be shifted away from corn ethanol and into less established technologies." Ethanol has no subsidies, unlike big oil. There was a blenders credit that went away 12/2011, which impacted the price at the pump. Ethanol is still the cheapest oxygenate on the market and allows refiners to produce a dirtier RBOB - the ethanol is utilized to get the octane level up to 87. The blend wall is a fallacy if E15 and E85 were allowed to be adopted by the marketplace but Big Oil will fight tooth and nail to maintain their monopoly on the fuel supply. Not one American has died for ethanol, something we can't say for Big Oil.

  • Report this Comment On November 19, 2013, at 6:07 PM, TMFBlacknGold wrote:

    @NePetes,

    Ethanol certainly has subsidies. While the blenders tax credit was done away with producers still generated Renewable Identification Numbers, or RINs, for each block of ethanol produced. RINs have real value and are still used to subsidize the industry.

    --Maxxwell

  • Report this Comment On November 19, 2013, at 6:49 PM, NOTvuffett wrote:

    Corn ethanol is stupid. Every careful analysis has determined that there is little to no gain in net energy.

    Cellulosic ethanol is interesting. However, this is not a technology ready for prime time. My guess is that if achieved it would be through enzymes or micro-organisms.

    I could go on and on, but the true believers are immune to logic.

  • Report this Comment On November 20, 2013, at 6:51 AM, MikeE751 wrote:

    Like NO Tvruffett (what kind of name is that, sorry no offense meant) comments. Way back, way way back, in Carter time, I was in ORNL. We studied very carefully the energy balance. Ain't there for ethanol in USA. Yes, ok Brazil is positive, but not in USA. Not 40 years ago, and not now. But what got me actually fired up enough to sign up as a foolish commenter was actually an earlier post: MWinMD above. The post was: "Here's a thought, if you can find a way to price into regular fossil fuels their REAL cost, to cover the billions American taxpayers and consumers are paying each year to rebuild, adapt and otherwise recover from fossil fuel-driven climate change, so that the price at the pump PAYS for all of it, then I'll be more than happy to see us let "sane markets" determine what "works" best. " This person is a danger to our economic system. And sadly, can likely vote as well. Sad that. Since there is obviously no clue from this person that climate "change" HAS NOT CHANGED in the last 16-17 years, I would suggest that this person is oblivious to reality, and can safely be ignored in future. Please, will be happy to provide any and all documentation of my statements. They are true.

  • Report this Comment On November 20, 2013, at 10:08 AM, VieuxCarre wrote:

    Great article. As to the point that the EPA just doesn't get it, I have to wonder how much weight is given to evidence vs given to political realities. The producers of these alternative fuels legally bribe the government to various degrees and that, no doubt has to be taken into account in decision making. I know that the Fool likes to stay apolitical, so I will leave it at that.

  • Report this Comment On November 20, 2013, at 8:42 PM, NOTvuffett wrote:

    @MikeE751

    lol, as for my name? i have sausage fingers. no offense taken. perhaps you should elucidate the meaning of the acronym ORNL. my guess is that most here wouldn't know what it stands for.

    since you have studied ethanol, it would be helpful if you told these good folks that ethanol in the usa is more expensive than in brazil mostly because of tariffs.

  • Report this Comment On November 21, 2013, at 8:21 AM, Timkatt wrote:

    @Innov8r,

    Attempting to monetize corn oil could also lead to falling prices for it leading to the same idling of facilities.

    Thanks for the comments about renewable diesel, you've given me something to research.

    @MWinMD

    We definitely need to remove the subsides that fossil oil producers get. It's far too much of an unfair advantage. Another all be it more controversial option would be to impose additional taxes on fossil fuels to spur more demand and research into renewable fuels.

  • Report this Comment On November 21, 2013, at 11:40 AM, damilkman wrote:

    I'm for removing the fossil oil subsidy if everyone on this list is for removing their mortgage subsidy. Most subsidies and tax credits exist because government was attempting to manipulate either the public or an industry. In the case of oil it was to encourage investment and exploration. In the case of homes it was to spur home ownership. It may be that the usefulness of the tax credit expired. But it becomes politically difficult to remove. I could make a case that the subsidy on home ownership contributes just as much to global warming as any oil subsidy. As far as I am concerned the ethanol mandate is the same as a subsidy. The industry would not exist if there was not a mandate for it to be used despite making no contributions towards energy independence. It exists because a lot of rich farmers are guaranteed a pretty penny because it generates more demand for corn.

    I have a great idea. How about we sprinkle ethanol on coal and then we can call it alternative energy and give a subsidy to coal companies. That has never been done before :(

  • Report this Comment On January 28, 2014, at 4:13 PM, thidmark wrote:

    "in return for shoving our civilization a little closer to the brink."

    Good grief ...

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