Biofuel has become a blanket term for many bio-based products, but differences in production methods and end uses do not warrant such an all-inclusive title. Proposed EPA regulations of biofuels as a whole do not appropriately take into consideration these differences, and in turn can be detrimental to some bio-based products and the companies that produce these products. In particular, regulations affecting Darling International (NYSE:DAR), Renewable Energy Group (NASDAQ:REGI), and other producers of products classified as advanced biofuels are overreaching and could severely limit the upside for investors in these companies.
Generic EPA classifications
Ethanol is not biodiesel, and biodiesel is just one of many advanced biofuels that can vary widely according to EPA classifications. Even within the biofuels subdivision of ethanol to which the American public is most exposed, there can be large variations in feedstock, by-product utilization, and end-use.
The 2014 Renewable Fuel Standards may include changes to the ethanol Blend Wall, but such changes are unlikely, and the more likely realized decreases in ethanol production are a mostly natural response to decreased fuel consumption. The more egregious components of the 2014 Renewable Fuel Standards relate to the call for reduced production of biodiesel and other advanced biofuels.
Diesel and its limits
Changes to the ethanol Blend Wall, if any, would be based on a decrease from the current 10%. The establishment of a Blend Wall for biodiesel, though not currently proposed, would reasonably be set to 5% or potentially higher yet, allowing for at least a four-fold increase in the current blending percentage. Furthermore, some renewable diesel products that are currently being generated can be used without blending.
The 2014 EPA proposed production limits on biodiesel do not include any increase in the current limits, though there is clearly room for safe growth without approaching theoretical blending limits where engine performance is affected. The proposed diesel production limits can thus be correlated to one or two things: Either the EPA is being influenced by outside forces that would have an interest in limiting biodiesel production, or the EPA simply does not understand biodiesel.
Biodiesel producers are appropriately upset over the proposed limits as they could greatly inhibit the growing industry's ability to meet natural market demand. The proposed limits for biomass-based diesel are set at 1.28 billion gallons for 2014 and 2015, equal to the 2013 limits, while the broader category of advanced biofuels are limited to around 2.20 billion gallons. While in the past, biodiesel production limits have fallen mostly in-line with production capacity, increases in production capacity are being readily realized by companies, including Darling International, who is partnering with Valero Energy (NYSE:VLO) in the creation of the largest renewable diesel refinery in the United States. An evaluation of feedstocks conducted by Darling International estimated that 1.9 billion gallons of biodiesel could be domestically produced without impacting feedstocks necessary to meet food requirements.
As the production potential continues to increase, EPA restrictions will limit the ability of the nation's most promising biofuel companies to function at fuller capacities that would in turn enable more financially efficient operations. If the proposed limits are finalized, the end result will be impaired growth and decreased margins for biofuel producers.
The biofuel industry is appropriately concerned over the 2014 renewable fuel standards proposed by the EPA. While the EPA claims to base production limits largely on current production capacities, growth realized by domestic biofuel companies has not been appropriately considered. As the EPA considers review of the proposed standards before finalization sometime in mid-2014, investors may need to temper their expectations for the biggest biofuel producers in spite of otherwise encouraging growth.
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Fool contributor Shamus Funk has no position in any stocks mentioned. The Motley Fool recommends Darling International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.