Can Biodiesel Investments Survive Without the Blender's Tax Credit?

The blender's tax credit, or BTC, is a fixed $1 per gallon tax credit given to the first fuel blender of a volume of biodiesel that contains at least one-tenth of one percent petroleum-based diesel fuel. It is separate from renewable identification numbers, or RINs, that are used to track monthly production and are priced on the open market. In other words, biodiesel and renewable diesel producers such as Renewable Energy Group (NASDAQ: REGI  ) and Darling International (NYSE: DAR  ) generate RINs with the creation of a product that is 100% renewable, either B100 (first generation) or renewable diesel (second generation), but must blend it down to 99.9% (or an acceptable blend for renewable diesel) to capture the BTC, too.

Of course, the BTC has to be active for the $1 per gallon gain to be realized, but the last iteration of the mandate expired at the end of last year. That promises to squeeze margins at Renewable Energy Group and Darling International this year. Can the leading and most efficient biodiesel and green diesel companies survive without the BTC? What are the chances the credit is reinstated retroactively later this year or next, as has happened the last two times the credit was allowed to expire?

Operating efficiencies only go so far
Renewable Energy Group took the expiration of the BTC into account when guiding first half 2014 revenue earlier this year. The company also assumed that major input costs, RIN prices, and the U.S. Environmental Protection Agency's proposed renewable volume obligations for bio-based diesel remained unchanged from the end of last year. The difference compared to actual 2013 results, which include revenue from the BTC, was dramatic:

 

Gallons Sold

Adjusted EBITDA

1Q13

38.9 million

$21.9 million

1Q14*

45-55 million

$5-$15 million

% Change

16%-41%

(32%-77%)

2Q13

69.2 million

$41.6 million

2Q14*

65-75 million

$0-$10 million

% Change

(6%)-8%

(76%-100%)

*Projected. Source: Renewable Energy Group, SEC Filings.

Those are some pretty scary numbers. A large increase in projected gallons sold during the first quarter of 2014 would not stave off a massive decline in adjusted EBITDA compared to the same period in 2013. While the original guidance was bad enough, the preliminary results recently provided by Renewable Energy Group for the first quarter were even worse. The company now expects adjusted EBITA of just $1 million-$3 million and for gallons sold to fall in the lower end of the range. Yikes!

The dismal preliminary results that undercut even a pessimistic outlook were caused by several things. First, the abnormally cold winter caused natural gas prices to rise, which lifted Renewable Energy Group's utilities bill and clamped down on diesel and biodiesel demand. Second, biodiesel prices fell and feedstock prices rose. Given unusually low feedstock prices and their trajectory at the time of the original guidance, I would have liked to see management account for higher and more realistic prices with its projections. Then again, the multitude of bad news in the last three months may have trumped any forward-looking prediction for inputs.

Source: Renewable Energy Group 4Q13 presentation.

The silver lining is that Renewable Energy Group was able to produce positive adjusted EBITDA despite a barrage of unfavorable conditions. That can be chalked up to the company's commitment to operational efficiency derived from willingness to invest in a national logistics network and the best process technology. And, of course, management's focus on the long term.

Darling International is not focused solely on producing renewable fuels, but has taken advantage of its leading rendering business (animal fats and used cooking greases, or the inputs for diesel) to create the Diamond Green Diesel joint venture. Renewable diesel is a hydrocarbon, has a different molecular structure than biodiesel, and can capture higher RIN values as a next-generation fuel. Despite the advantages, it is still blended into the existing petroleum-based fuel supply, and therefore benefits from the BTC. Luckily, Darling International's diverse business structure has insulated it from the expiration of the credit. In fact, the company has benefited from the increase in feedstocks since the end of last year.

Foolish bottom line
Positive adjusted EBITDA and business diversification aside, there is no denying that the BTC would be a welcomed addition to the businesses of Renewable Energy Group and Darling International. However, I think it's important to admit that while uncomfortable, both businesses can survive without the BTC. You may want to account for the volatility caused by the continual cycle of reinstatement and expiration of the credit when investing in the industry (there are several bills on the table that would retroactively reinstate the BTC for a third time and keep it active through the end of 2017). Or, you can do what I do and keep a long-term approach, using knee-jerk reactions to short-term uncertainties as buying opportunities into great businesses.

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  • Report this Comment On April 17, 2014, at 4:16 PM, DrGoldin wrote:

    I've been rooting for REGI and my thesis has been that the company is profitable even without the blender tax credit, but today I cashed in my chips. The post-BTC numbers are just too alarming. Also, I'm very concerned about this statement from their press release: "Our original guidance also assumed constant pricing for energy and feedstocks, however biodiesel prices decreased and feedstock costs increased more than expected." Why on earth would management expect "constant pricing" for anything? There has to be a better way to anticipate rising feedstock prices than to assume that it won't happen and then say "Oops, we didn't expect that."

    If the BTC is renewed, I'll get interested again (and people who are staying in the stock will be rewarded).

  • Report this Comment On April 17, 2014, at 7:22 PM, TMFBlacknGold wrote:

    @DrGoldin,

    Thanks for the update on your position. I'm not sure why they assumed constant pricing for feedstocks, either (that meant same as the average from 4Q13). Perhaps they thought prices would continue to slide and they would come out on top? The company does hedge its business when and where possible, but that only goes so far.

    I'm more interested by the long-term opportunities, such as REG Life Sciences. In fact, I'll be attending the analyst meeting on April 22nd to learn (and ask) more and will report my findings to the TMF community.

    Best,

    Maxxwell

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