The American Ethanol Industry Needs to Innovate to Avoid Disaster

Uncle Sam leads the world in ethanol production, but he'll soon have a very difficult time finding buyers for all of his gallons. Can Valero and Green Plains Renewable Energy innovate their way over the storm clouds?

May 5, 2014 at 8:00AM

Images

Not too long ago, our ethanol industry was laughable at best. Today, we may be too good at producing the blendstock. Source: USDA/Wikimedia Commons.  

The United States is the world's leading ethanol producer, accounting for nearly 62% of world production. It holds down the top spot by sporting 211 ethanol production facilities with a combined nameplate capacity of 14.6 billion gallons per year. Eight more facilities are under construction, which will add an additional 620 million gallons of production when completed, pushing America's ethanol capacity to over 15 billion gallons per year. While that seems to paint a picture of growth in the industry, consider that most new facilities utilize next-generation feedstocks and technology platforms -- making them drastically different in terms of value. Another depressing statistic: The U.S. has roughly 1.26 billion gallons of idle capacity.

There is a long laundry list of reasons for idling facilities. The drought that ravaged corn stockpiles in 2012 cleared out many inefficient operators and sent production costs skyward, forcing even the most efficient producers to cut back. Although feedstock prices have dropped recently, uncertainty surrounding the Renewable Fuel Standard and the fact that fuel blenders have hit the Blend Wall point to storm clouds on the horizon. Worse yet, as gasoline consumption falls with an increasingly efficient automobile fleet (and fuel economy set to nearly double by 2022), the amount of ethanol needed for a national 10% blend rate falls, too. Simply put, the U.S. has way too much ethanol capacity for present and future needs.

The only way for producers to make it out alive is through innovation. Leading companies such as POET, Abengoa, and DSM may lie outside of the reach of investors, but you can use their example when looking for investment opportunities. How are producers such as Valero (NYSE:VLO) and Green Plains Renewable Energy (NASDAQ:GPRE) turning the industry's capacity glut into an opportunity?

Forget transportation woes
Why in the world would one of the country's largest traditional refiners want to produce ethanol? The battle between ethanol producers and Big Oil companies alone makes that paradoxical. Account for the jabs at the biofuel's low margins by Valero management on quarterly conference calls and the head scratching could require medical attention. But if you look deeper, you'll see the brilliance.

Valero Renewables is the proud owner of 10 state-of-the-art ethanol plants with a combined production capacity of 1.2 billion gallons per year. "State of the art" means the facilities efficiently monetize waste streams and attain optimal yields of 2.8 gallons per bushel of corn (Valero produces 2.84 gallons per bushel across its fleet). In addition to efficient production, Valero is able to leverage its extensive logistics and transportation network -- built for its refining and retail business -- when selling the 3.3 million gallons of ethanol it produces each day. Since ethanol cannot be transported in traditional pipelines, transportation is expensive and requires a bit more logistics than products such as gasoline would.

G

Valero will move mountains (or highways) to improve its logistics network. That's good news for ethanol. Source: Benicia Refinery project description. 

While not all of the ethanol produced by Valero is blended into its gasoline products, the ethanol business allows the company to capture value upstream (production) and downstream (blending). Will other large refiners soon climb the list of the largest and most efficient ethanol producers? They certainly have the critical advantage of world-class transportation and logistics networks, which each of the largest ethanol producers in the country boasts. But perhaps more innovation will be needed to make ethanol production profitable in tough market conditions.

Recycling carbon with algae
Green Plains Renewable Energy is the continent's fourth-largest ethanol producer with roughly 1 billion gallons of production capacity. It also produces 250 million pounds of non-edible corn oil each year and owns 822 million gallons of annual blending capacity. You can bet it has a world-class transportation and logistics network, but its biggest competitive advantage may be a novel technology platform being developed by BioProcess Algae. The ethanol leader owns approximately 60% of the developmental algae company, up from just 35% in early 2011.

G

This facility covers five acres of land, but could soon be expanded to 400 acres. Source: BioProcess Algae YouTube video.

What makes the technology so disruptive? The modular platform is designed to convert the ultimate waste stream, carbon dioxide, into algae biomass for animal feed, nutraceuticals, fish feed, chemicals, and fuel. It's a pretty simple idea. Carbon enters the ethanol production process as sugar from corn and leaves in the form of ethanol (sold), distillers' grains (sold), corn oil (sold), and carbon dioxide (discharged into the environment). Ethanol facilities pay for the carbon that escapes into the atmosphere, so why should they just throw money away? Producing high-value products from carbon dioxide emissions would greatly enhance the margins of ethanol production and distribute risk across multiple, unrelated markets.

If the phase 3 facility above is successful, then the decision will be made to expand the facility to a larger commercial operation. Better yet, if economical, the modular platform could be licensed to any manufacturing facility that emits carbon. Given the massive opportunity, I firmly believe that carbon dioxide will be monetized for all manufacturing facilities in the future -- but we'll have to see if Green Plains Renewable Energy will be a player in the new industry.

Foolish bottom line
How bad is America's ethanol glut and overcapacity? Imagine taking Valero's entire 1.2 billion gallons of production off the market, which accounted for over 12% of the company's income in 2013 despite representing less than 2% of its total assets. The problem will only get worse as the country's gasoline consumption declines and requires less ethanol to reach 10% blend rates. Smaller, less-efficient producers will be forced out of the market, while larger producers will be forced to become ever more efficient and innovative. Luckily, Valero and Green Plains Renewable Energy appear to be on the right track.

Three stock picks to ride America's energy bonanza
Ethanol isn't your energy play of choice? That's fine, because record oil and natural gas production is revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, The Motley Fool is offering a look at three energy companies using a small IRS "loophole" to help line investor pockets. Learn this strategy, and the energy companies taking advantage, in our special report "The IRS Is Daring You To Make This Energy Investment." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free. 

Maxx Chatsko has no position in any stocks mentioned. Check out his personal portfolioCAPS pageprevious writing for The Motley Fool, or his work for SynBioBeta to keep up with developments in the synthetic biology industry.

The Motley Fool has no position in any of the stocks mentioned. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers