Reality and Biofuels Collide; Biofuels Lose

In 2007, the U.S. government set biofuel targets based on projections of future gasoline consumption. The recession, however, changed usage patterns and, now, the Environmental Protection Agency (EPA), which updates the targets, has been forced to trim those goals. That's bad in some ways, but could be an opportunity for FutureFuel (NYSE: FF  ) to grow.

Not enough gas
Gasoline use has fallen since the 2007 to 2009 recession. Science is the problem facing biofuels, because ethanol, one of the big beneficiaries of the Renewable Fuels Standard mandates, can actually hurt auto engines if it makes up more than 10% of gasoline. The mandates are right up against this "blend wall," so they have to be loosened.

Source: EIA

This isn't the first time that the EPA has had to act, but this time it's reduced mandates across the board. That could have a negative impact on companies like FutureFuel that make bio-diesel. With a potential reduction in demand, prices would likely slump.

Luckily, about a third of FutureFuel's third quarter revenue came from its specialty chemicals business. So there's more to the company than just bio-diesel. And, the company has no long-term debt and nearly $100 million of cash on the balance sheet. So, any downturn could turn into a long-term opportunity.

In fact, management recently said, "We'd like to make acquisitions ... [but the prices people have] been willing to pay and the price expectations from the sellers have just been something we didn't want to participate in." If the market gets hit, however, "you're going to see more properties realistically priced on the marketplace."

A changing market
The problem that the biofuels industry faces right now, though, is that the market is fundamentally changing because of low natural gas prices. For example, Clean Energy Fuels (NASDAQ: CLNE  ) has been pushing the use of natural gas in fleet vehicles. One of the biggest success stories has been with trash haulers like Waste Management (NYSE: WM  ) and Republic Services (NYSE: RSG  ) .

Clean Energy estimates that around 60% of the trash trucks purchased this year will use natural gas. Waste Management is a poster child for this shift, with over 2,000 natural gas vehicles. In 2012, over 70% of its truck purchases were natural gas. Every one of those new trucks is a truck that will never use FutureFuel's bio-diesel.

How big a deal is that for FutureFuel and the biofuel industry? Waste Management estimates it avoids the purchase of 8,000 gallons of diesel a year for each natural gas truck. Simple math shows that Waste Management alone now uses over 16 million gallons a year less diesel than it used to.

Republic, meanwhile, estimates that it uses abut 140 million gallons of diesel a year. But half of the thousand or so new trucks it buys annually use natural gas. So diesel use should fall by about 4 million gallons every year, using Waste Management's fuel savings estimate. That's demand that will help build Clean Energy's business, but spells less demand for FutureFuel's bio-diesel.

And Clean Energy is also going after the long haul truck market. It estimates the long haul opportunity is over 12 times as large as trash hauling. Clean Energy is so excited by the growth potential that it's been willing to lose money building out a network of fueling stations on the nation's highways so it's ready when demand starts to pick up. Bio-diesel will face stiff competition if Clean Energy proves correct on the long-haul shift.

Risks, but still opportunity
Although cheap natural gas poses risks to the adoption of FutureFuel's bio-diesel, that doesn't mean there isn't a long-term opportunity. Like natural gas, bio-diesel could also see increased use by gaining share from diesel. So there's room for Clean Energy and a profitable and well-financed player like FutureFuel. Still, if you like biofuels, it's worth keeping an eye on natural gas since that fuel is increasingly becoming the competition.

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  • Report this Comment On December 10, 2013, at 1:46 PM, richtidebruin wrote:

    Mr. Brewer, You have some insightful thought regarding the usage of Nat Gas, but you specifically point to WM and other trash haulers, which make greater economic sense for them (than long-haulers) to switch to NG since they can reclaim methane from landfills these companies have an interest in. But in as much as the numbers you provide seem significant to the bio-diesel market, my assertion is that it is just a small niche, and not enough to move the needle. A better indicator IMO would be to look at industry statistics regarding Heavy Duty truck production by fuel. Also consider that off-setting the transition to NG in a few niche markets is the emergence of more diesel options in the retail automotive market - see Jeep, Ram, Audi, and others such as Mazda, BMW, M-B are on the way - in response to ever-increasing CAFE standards. Also it's important to note that every diesel engine is not capable of utilizing B20, so if one is trying to "gu"-estimate net future potential usage, there are a lot of additional variables to consider.

  • Report this Comment On December 10, 2013, at 1:51 PM, richtidebruin wrote:

    Disclaimer: I also have no position in any of the stocks identified, but do own a diesel vehicle that is not B20 compatible.

  • Report this Comment On December 10, 2013, at 1:58 PM, headless wrote:

    Ethanol should never have been accepted as a biofuel. Butanol makes so much more sense. Made from same feedstocks as ethanol. Higher yield. Direct replacement and mixes with gasoline. No vehicle modifications needed. Ethanol worked for Brazil because of their sugar surplus and wanting to prop up sugar prices. Butanol should be the US biofuel of choice.

    Should also be using Thorium reactors for our nuclear supply instead of Uranium and Plutonium. Thorium much more available and less expensive.

  • Report this Comment On December 10, 2013, at 3:51 PM, zcr00 wrote:

    Isobutanol does look like a good fuel goin forward. It has a higher energy density than ethanol, it doesn't absorb water, and like you said it requires no modifications. Also some ethanol plants already have plans to switch to isobutanol if needed, plus with the higher energy density it won't require as much effort to move around.

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