In what amounts to cramming for an important exam at the last minute, the global energy industry appears to be woefully underprepared for a new global fuel standard that goes into effect on Jan. 1, 2020. That's when oceangoing shipping vessels have to begin using fuels with just 0.5% sulfur content, down significantly from 3.5% today. The new low-sulfur fuel rule could create an additional 800,000 to 2 million barrels per day of diesel demand, or an extra 12 billion to 30 billion gallons per year.
The consequences -- and opportunities -- will be impossible to overlook. Sweeter crude oils (such as American shale) will be in higher demand. Global refineries will have to retool to increase distillate output, although analysts think they're already going to fall short of demand. Maritime shippers will for the first time be competing with long-haul highway truck fleets for fuel, creating a market pressure that could be the tipping point for adopting natural-gas fuels on land and at sea. And that's just barely scratching the surface.
Considering the global impact across the energy supply chain, and the fact that 2020 is right around the corner, we asked three contributors at The Motley Fool what areas and stocks they'll be watching as the deadline approaches. Here's why they think renewable diesel leader Renewable Energy Group (REGI +0.00%), Marathon Petroleum (MPC 1.15%), and Clean Energy Fuels (CLNE 0.48%) should be monitored by individual investors in 2019.
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Location, location, location
Maxx Chatsko (Renewable Energy Group): If the world needs an additional 12 billion to 30 billion gallons of low-sulfur diesel per year for maritime shipping come 2020, then highway-based trucking fleets may need to scramble. That bodes well for Renewable Energy Group (and Clean Energy Fuels, as Jason describes below), North America's largest producer and supplier of biomass-based diesel, which would be able to maximize the opportunity thanks to strategic and logistical advantages.
While the company owns 575 million gallons per year of biodiesel and renewable diesel production capacity (including some in Europe), it doesn't just sell fuel to petroleum refiners looking to blend renewables and meet their federally mandated quotas for the year. The business is increasingly focused on higher value opportunities downstream. For instance, in the first nine months of 2018, the company generated 33% of product revenue from petroleum majors (blending), 36% from convenience stores, and 29% from direct sales to fuel distributors and truck fleets.
Renewable Energy Group continues to build out a national network of fuel blending and distribution terminals ahead of the 2020 deadline. It expects to close up to 10 terminal agreements by the end of 2018 and has already added 16 new truck fleet customers this year. Perhaps most important is where the expansion is taking place. Nearly 74% of gallons sold in the first three quarters of this year were in states with renewable fuel mandates, which create higher selling prices compared with national averages. These states -- California, Texas, and Illinois alone combine for roughly 1.2 billion gallons of biomass-based diesel demand -- are where the company is focusing capital investments targeting growth.
Regional fuel policies also could amplify price increases resulting from soaring global diesel demand. For instance, clean fuel consumption is expected to grow at a healthy clip in California thanks to its ambitious low-carbon fuel standard (LCFS). Biomass-based diesel demand in the state could nearly double from 2017 to 2020 as a result, no doubt a big factor in Renewable Energy Group and Phillips 66 announcing their intention to build a large-scale renewable diesel facility on the West Coast by 2021. Simply put, the continent's largest and most capable biodiesel producer could realize considerable momentum from the new global fuel standard just over the horizon, thanks in no small part to where it has focused its operations to date.
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Already designed for the new fuel standard
Tyler Crowe (Marathon Petroleum): Setting aside that Marathon Petroleum's stock sells for a dirt-cheap valuation and that its recent acquisition of Andeavor will generate immense cost savings, the nation's largest refiner is already well designed to meet stricter fuel emissions standards and demand for lighter products.
A refinery's ability to refine crude into higher-value products such as gasoline and diesel is measured by what is known as the Nelson Complexity Index -- the higher the number, the greater ability to produce high-value products from crude. The global average score for refineries is 5.7, whereas Marathon's is above 10 after the merger. Also, Marathon has the most hydrocracking and -coking capacity in the country. These two refining processes are what refiners need in order to produce high percentages of diesel (known as distillate yield) from a barrel of crude. Selling gasoline and diesel overseas is already a lucrative business for refiners because fuel sold overseas doesn't need to comply with U.S. ethanol blending standards and the costs associated with compliance.
Another aspect that makes Marathon suitable for the upcoming fuel standard changes is that it has considerable export capacity already, with the potential to increase it further thanks to considerable refining capacity on both the Gulf Coast and West Coast. Management has already noted that it intends to increase distillate yield at several of its coastal refineries to meet growing diesel demand.
While there is still some uncertainty about how well Marathon's management can execute the Andeavor integration, the company is incredibly well positioned to take advantage of America's cheap crude prices and its rapidly growing production. With its stock trading at a PE ratio of 7.6, investors should have this stock on their radar.
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The best stock to profit from the on-road implications
Jason Hall (Clean Energy Fuels): Over the past several years, diesel prices have steadily gotten more expensive on rising crude oil prices:
US Retail Diesel Price data by YCharts.
This has huge implications across the economy. Fuel is often one of the biggest line items in a trucking company's budget, and this expense gets passed along to the companies using them, and eventually to consumers. And while crude prices have started to cool, diesel prices haven't really come down that much, and the impact of adding as much as 30 billion gallons of global diesel demand within a year will almost certainly keep diesel prices high for years to come.
Electric and hydrogen have gotten a lot of attention over the past year as alternative fuels for heavy transit, but the reality is, neither is road-ready today, or likely to be available -- or affordable -- at commercial scale for years to come.
But natural gas is road-ready, cheaper than diesel, and has a proven track record as a functional, reliable fuel for commercial transportation right now.
The company best positioned to profit from this is Clean Energy Fuels. It's been a tough few years for investors in the company, but today it's in the best position it has ever been. It generates positive cash flows, has by far the biggest network of public and private natural gas stations in the U.S., and counts energy giant Total as its biggest investor.
Heavy trucking in North America consumes more than 30 billion gallons of diesel annually. Compared to the roughly 350 million gallons of natural gas Clean Energy Fuels sells each year, that's an enormous addressable market that's set to migrate away from diesel in the years ahead.
